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Delivering Value: Essential Tools to Help Procurement Optimize The Strategic Sourcing Process

Posted on January 9, 2013

The Value Basis for Procurement

As the procurement function has become more sophisticated, the perpetual corporate charge-for-growth has pushed the function to identify and deliver value across the organization on a constant basis. To this end, while many tools and techniques have been made available to the sourcing professional to achieve these aims, the most tangible means are, in many respects, the most fundamental i.e. optimal execution of the strategic sourcing process. But what is ‘optimal’ strategic sourcing?

While there are many ways to define the term and many constituent elements that comprise it, at its core, optimal strategic sourcing has four key characteristics. It is:

  • Structured and systematic
  • Fact based and data driven in nature
  • Inclusive – of both internal and external perspectives
  • Rigorously applied

In other words, optimal Strategic Sourcing is actionable and strategic–with its essential emphasis to deliver tangible benefits across a range of parameters (of which cost is but one). And strong execution of the process consists of understanding and applying fundamental tool sets that should form the core of any sourcing professional’s arsenal. In this article, we will overview three specific tools that can help the sourcing professional develop actionable intelligence, specifically:

  1. The Supply market analysis
  2. Should cost model
  3. Negotiations fact pack

Tool 1: Supply Market Analysis
The Supply Market Analysis (SMA) is an oft-used tool in many respects, in that various forms of such analyses are widely available for many categories on a syndicated and/or free basis, and as a result, many feel that they have this tool covered in appropriate depth as they embark on their sourcing programs. The stark reality is that, depending on the category in question, sufficient diligence is usually not observed – either in definition (what constitutes a strong SMA), or in execution (no, simply getting intelligence from your vendor set is not good enough).

So what is an effective SMA? A robust analysis covers seven essential elements, as depicted in the schematic below:

Note that the elements listed above are not all equivalent in terms of nature and sequence. Some are distinct, while others are dependent on the distinct elements. For example, understanding the competitive landscape and developing product and technology trends are distinct areas, but the Political Economic Social and Technology (PEST) analysis and the Porters Five Forces analyses are dependent on many of the other elements to develop. As such, the basis for developing a strong SMA is robust, structured and varied research in order to extract the essential information and data that will comprise the overall analysis:

  • Extensive Secondary Research: Typical Tools here include subscribed databases, company websites, industry/market reports, ministry and association websites. Irrespective of source, it is important to:
  • Define the market appropriately – identify current as well as emerging substitutes, for example Deploy a combination of top-down and bottom-up approaches to identify key players, positioning, market structure, etc.
  • Qualify and caveat data sources – always corroborate numbers from multiple sources
  • Consider the economic environment when evaluating forecasts – context is key to interpretation
  • Targeted Primary Research: A must have for a strategic category, as rarely are all key questions answered through published literature alone. This means:
  • Identify industry stakeholders – both Paid and Unpaid
  • Evaluate the source – assess the individual’s agenda and hence the quality of the insight provided
  • Look broadly – speak to vendors, market experts, buyers, etc. Do not limit your sources
  • Interpretive Analytics: this is putting all of the above together i.e. thinking through the data and information to develop insight, including structural analysis (to understand the true nature of the competitive landscape), Porter’s Five Forces analysis, etc.

Tool 2: The Should Cost Model
The second major tool to deliver actionable intelligence is the should-cost model. A strong model provides a level of insight into the cost structure of any given product or service that allows for a detailed understanding of those key cost elements that drive the price of any given category. Effectively executed, the model:

  • Dissects the various cost elements of producing a certain product
  • Involves granular analysis where a representative facility operating at a certain throughout is considered for cost simulation
  • Embeds product and sector knowledge including
  • The commercial manufacturing process
  • Proportions of various raw materials used at different stages
  • Energy and other utility costs
  • Direct labor and overheads
  • Assesses and estimates producer margins

(In many instances (particularly Direct Categories), there can be commercial by-products, tax incentives, government rebates, etc., that need to be accounted for and then appropriately treated within the model.) Of course, it is critical that the cost model be considered at various levels – product/service, individual supplier and region-specific.

The process to develop it is three-pronged:

  • Data Collection–This is the secondary data collection and primary research that needs to be done to arrive at the necessary parameters/inputs. The analysis at this phase should look to identify the cost elements, evaluate the production process, understand nuances behind raw material inputs and costs, etc.
  • Data Analysis–This is the more technical phase of the analysis, where the individual variable costs are analyzed through fundamental derivation and validated through numerous sources. The assessment covers everything from material input levels, to production specifics, to overhead allocation approaches and limits
  • Cost Element Estimation–In this third phase, the individual cost elements are summed up and the model is thoroughly checked and tested for validity at the overall level

Needless to say, a strong should-cost model relies on multiple points of information and data, with the information elements triangulated and validated based on both primary and secondary research. The output, though, is worth the time and effort put in, as it helps to provide a strong economic, fact driven basis for discussion with a supplier or as a key input to strategy.

Tool 3: The Negotiations Fact Pack
The third major tool we will discuss here is the Negotiation Fact Pack. Tackled in many different forms (of varying levels of rigor), a robust fact pack is a set of tools and frameworks that provide targeted support during negotiations across a range of specific parameters and specific suppliers.

In its most ideal form, the pack provides: All relevant market information focusing on a specific supplier’s bargaining power Insight into spend data – volumes, patterns, diversity of spend, etc. Relative positioning vis-à-vis its competitors, the buying company, the industry and beyond Insight into capacity, operating rate, costs, market conditions, etc., and implied leverage Thus, the specific components of a Negotiation Fact Pack are varied but can include the following:

  • Supplier’s Product focus and related pricing power
  • Supplier Cost pressures
  • Supplier Industry vs. Buyer Industry bargaining power
  • Impact of market events on the supplier
  • Impact of competition on the bargaining power of supplier
  • Impact of demand on industry pricing
  • Industry structure and dynamics

Most tangibly, a thorough fact pack is of direct value during contract renewals, re-negotiations and price push backs with suppliers.

In Summary
The above represent three core tools (among others) that should form the foundational basis for when a category leader undertakes the strategic sourcing process. The emphasis here is on the basics–facts, data, rigor and analysis. To ensure this is achieved (irrespective of the specific tools deployed), there are several common drivers for success:

  • Senior-level commitment to intelligence as a tool to ensure sourcing success
  • Rigorous due diligence – consistent, structured and methodical approaches
  • Inclusion of a wide range of sources of insight – primary and secondary
  • Ability to leverage ‘analysis’ beyond the data – what does the information mean?

By observing these principles, the sourcing professional is then able to drive the type of actionable intelligence that is essential to ensuring the success of his or her category strategy.

For specific examples and an application of the above tools, email info@thesmartcube.com.

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Plummeting Polysilicon Prices: What Does it Mean for Solar?

Posted on January 6, 2013

Energy crisis has been the topic of discussion for many years now. Supply constraints, burgeoning demand, and the continuous surge in energy prices serve as constant reminders that the need to explore newer sources of energy should be more intent.

“I’d put my money on the sun and solar energy, what a source of power! I hope we don’t have to wait until oil and coal run out, before we tackle that.” – Thomas Edison.

The prolific inventor of the electric bulb realized the power of the sun way back in the early 1900s. Despite the enormous energy that can be tapped from this source, solar power accounts for less than 1% of the total global energy demand. Needless to say, it is still considered an “alternative” source of energy by most.

What is holding back governments and industries from actively harnessing solar power? Why has the use of solar energy been restricted to small pockets and just a few applications? A multitude of conferences and energy summits around the world have tried to address these questions, but words have evaporated and not much has changed.

Multiple factors and forces impact the viability of solar power as a competitive source of energy. One of these is the price of polysilicon, a key feedstock that is used to manufacture Photovoltaic (PV) cells. The market for this key feedstock witnessed developments in the past decade—with some having the potential to change the way we look at solar power.

Around 2003, the term ‘clean technology’ evolved as the ‘next big thing’ in response to the mounting pressure to shift focus from fossil fuels. This led to an increase in the demand for solar panels, primarily driven by tariff incentives provided by the likes of German and Spanish governments. High growth rates during 2004–2008 were reflective of an emerging industry, where demand outpaced supply. Market forces led to an exponential rise in polysilicon prices, from $30/kg in 2003 to $475/kg in 2008.

Anticipating the growth momentum to continue, many new players (especially in China) entered the polysilicon market during this period. Even existing players increased their capacities to tap into the growing demand for solar panels.

However, with the onset of the global economic crisis in 2008, investor confidence declined, financial tensions soared, and the world scrambled to maintain status quo. With the money markets in turmoil, solar power was pushed to the back-burner. Aggressive withdrawal of financial incentives by the governments of Spain and Germany (key demand drivers) made matters worse. The supply–demand scenario reversed and installation demand for solar panels failed to keep pace with polysilicon supply post 2008. To put things into perspective, global demand for solar modules increased only 15% against a 32% increase in polysilicon availability during 2008–2009.

 

 

 

 

 

 

 

 

By December 2011, polysilicon prices plummeted from a high of $475/kg in February 2008, to $26.5/kg. Industry analysts saw this as the tipping point and predicted a strong growth in solar installations worldwide. One would imagine that a 95% decline in the prices of feedstock, accounting for ~25% of PV cell production cost, in a matter of 45 months would be sufficient to spur activity among investors and developers. But was it? Was there a dramatic rise in interest for solar energy?

A year later, The Smart Cube analyzed whether this opportunity—touted as the next big thing for solar power—really hit its mark.

During 2012, investor confidence and activity in the solar energy space was lukewarm, at best. Growth in number of solar PV installations was marginal (11% Y-o-Y in 2012), compared with the previous year (~55% Y-o-Y in 2011). Overestimating demand, both solar modules and polysilicon markets struggled with oversupply and high inventory levels during the year. The widening gap between supply and demand caused polysilicon prices to further crash to $17/kg in December 2012.

Declining polysilicon prices did not appear to be as strong a growth driver as they were thought to be. Many other factors including government support, incentives and subsidies, capital requirements, and technological improvements may have had a higher impact on investment activity last year.

While rock-bottom polysilicon prices may not be the strongest catalyst, they certainly can be an enabler that propels solar power to become competitive in the years to come.

So what will happen to polysilicon prices? Three important market forces are most likely to impact pricing in 2013.

1)      Production Levels: A lot will depend on the strategy adopted by industry players going into 2013—will they get lured by an expected demand increase in emerging economies in the short term and keep production levels high; or will they acknowledge the dismal state of the industry and rationalize production based on market conditions? While 2012 saw new entrants and continued production by market participants, several players have begun delaying capacity expansion plans or reducing production in the last couple of months.

2)      US–China Trade Dispute: There is an ongoing trade dispute between the US and China, where the former has imposed anti-dumping and anti-subsidy tariff on cheap solar panels from China. In retaliation, China has undertaken investigations and is likely to do the same for US-imported polysilicon. Imposition of such tariffs may lead to a rise in the prices of polysilicon (and solar panels).

3)      Market Consolidation: Poor performance of the polysilicon market in the last couple of years has caused a flurry of bankruptcies and increased M&A activity. In fact, it is estimated that only a dozen players, out of the 170+ manufacturers globally, will survive the storm in the coming years! This level of consolidation would increase the bargaining power of the remaining players and nudge prices upwards.

When is the best time to invest in solar energy? Will buyers wait for prices to drop further? At what levels will polysilicon prices finally stabilize?

With multiple market forces at play, interesting times lie ahead. In the next piece of this series, we will look to explore the impact of government support and incentives on solar market activity.

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Free e-invoicing: The Road Ahead

Posted on January 3, 2013

Electronic invoicing or e-invoicing refers to transmission of invoices over the Internet. It offers a number of benefits to organizations, including streamlining of accounting processes, reducing paper volume, offering higher receivables, helping in timely delivery of invoices and faster customer payments, reducing the number of lost invoices, and increasing visibility and control over various processes. Moreover, e-invoicing has much bigger ramifications for the public sector. Across the US and Europe, governments are adopting e-invoicing to enable back-office savings that help in decreasing spend. Further, government authorities are promoting early payment incentives in a bid to inject liquidity. The governments of Norway, Denmark, Spain, and Greece have announced e-invoicing programs in the past couple of years, and more countries are expected to follow suit. For instance, from July 2012, the Norwegian government only accepts invoices from suppliers in electronic format, thus fueling the adoption of e-invoicing.

 

 

 

 

 

 

 

 

The current e-invoicing landscape is dominated by established providers such as OB10, Ariba, Crossgate, and GXS. These companies primarily cater to large corporations with large invoice volumes. They charge customers on the basis of the transaction (invoice) volume, as well as fixed cost for on-boarding. This can constitute a substantial cost for large, multinational corporations with a diversified supplier base. However, servicing needs of small and medium enterprises (SMEs) are significantly different from those of large corporations. As a result, charges can prove to be a deterrent for these SMEs.

Free invoicing–the new wave in e-invoicing

Recently, there has been an emerging trend of service providers offering free, web-based e-invoicing services, leveraging the cloud delivery system. These players, including Tradeshift, Maventa, Blinksale Simply Bill and Maventa, primarily target the SME market.

Impact on paid providers and the e-invoicing market

The new players offering free e-invoicing services are not expected to garner a large market share in the immediate future. However, taking into account the needs of large multinationals (looking to boost supplier on-boarding) and SMEs, these players may exert downward pressure on paid provider pricing. Additionally, the shift in market focus toward SMEs is likely to drive the mass adoption of e-invoicing across the board.

For example, Tradeshift, a prominent free e-invoicing player, was established in 2009. Currently, it services a rapidly growing supplier network that includes 60,000 customers from 200 countries. Its customers include the Danish and French governments, the UK’s National Health Services, Vestas Wind Systems, Maersk Group, Kuehne+Nagel, DSV, TDC, and Coop. Other players in the space are gaining similar traction.

The free e-invoicing scenario is expected to evolve in the following three phases:

Phase 1

Players offer basic e-invoicing services for free, which helps quickly establish a network base, as SMEs are able to join the network without incurring any costs. The providers do not charge for on-boarding and their offerings are targeted at SMEs and low-invoice volume players. This is achieved by offering SME-friendly propositions. In this phase, the focus is on driving mass adoption of e-invoicing. The companies will continue to focus on maintaining an open structure to allow customization.

Phase 2

In this phase, companies will begin to offer additional, value-added services such as digital signatures and archiving. The focus is likely to be on the adoption of standardization format of reporting (PDF, XML, etc.). The on-boarding costs will remain low. The players will offer interoperability or the freedom to switch platforms, which will enhance cross-platform exchange. In addition, the players will focus on targeting clients with higher invoice volume. This will be led by an expansion in capabilities. Further, players will focus on expanding their supplier network and reach in order to improve their service offerings.

Phase 3

In this phase, companies will offer services under the freemium model. Service offerings will comprise free solutions along with full-fledged paid solutions (thus moving away from being only free service providers). In the near future, the companies are expected to move to the ‘freemium’ model, which encapsulates a basic, free offering, coupled with paid offerings such as value-added and premium services. This is in line with the business model of most online service providers. In the freemium model, most users get access to a service for free and they are subsidized by spaying customers who pay for access to enhanced features, including most technology firms such as Skype and LinkedIn. This will be aimed at larger corporations with a significant volume of invoices exchanged, as service providers will look to target high-volume companies to expand their client base in a bid to occupy larger market share. Players will also be required to focus on security, ease of use, cross-platform exchange, and regulatory compliance in various countries. Large corporations will demand such facilitates before considering a switch to such players.

Case study – NHS revolutionizes invoicing

The adoption of e-invoicing shows immediate results. Anglia Support Partnership (ASP), part of UK’s National Health Services, was managing nearly half a million paper invoices across thousands of suppliers—leading to a burden on resources and increasing the potential for error. 42 employees were managing 17 clients, processing 450,000 invoices annually from over 10,000 suppliers. Within four weeks of adoption of e-invoicing, 29% of its suppliers switched to Tradeshift (significantly higher than the industry average of 10%, as claimed by most paid service providers), along with a marked reduction in manual inputs and a significant improvement in data accuracy.

“We have been amazed at the speed and impact of adoption by suppliers. Our targets had been fairly conservative; in the first year, we believe we can make a 5% efficiency saving, and up to 20% after second year. After three years, we hope to get 70–80% of all our invoices through this system. It is still early, but I have no doubt that we will meet and exceed these targets. Once the rollout phase is complete, we plan to make it mandatory for all suppliers.”– Nick Wood, Corporate Director, ASP (2011)

‘Freemium’ e-invoicing model is sustainable

Invoicing is a network service that requires maximum reach for increased efficacy—participation of all stakeholders within the same ecosystem. The most definitive way to achieve that objective is to lower entry barriers. The entry of new players exert downward pressure on prices in order to attract new customers, as customers look to reduce non-essential expenses in view of sluggish macroeconomic realities.

Therefore, the ‘freemium’ e-invoicing model is a sustainable phenomenon and is expected to have a disruptive impact on current industry pricing mechanisms. Further, it remains to be seen how the players tackle pertinent issues such as interoperability, regulatory compliance, security and low supplier adoption rates that plague the industry. Moreover, larger players are re-evaluating their offerings to serve SMEs, as well as major corporations. Although the potential of e-invoicing for industry players is yet to be fully explored, this service will surely offer enhanced value propositions to customers.

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Betting on Abe-nomics?

Posted on January 2, 2013

The Liberal Democratic Party, led by Prime Minister Shinzo Abe, has come to power with a bold economic agenda. They want the Bank of Japan (BOJ) to reverse the appreciation of the yen and bring the country out of the decade and a half long deflation by increasing the inflation target from the current 1% to 2%, expanding its asset purchase programme (a.k.a. Quantitative Easing) and purchasing foreign bonds to influence the supply and demand dynamics of the yen. While the election of the new government has certainly changed the policy landscape, we think that there are valid reasons to be skeptical about its efficacy in the medium term.

Let’s take the BOJ’s inflation target first. As shown in the chart below, despite a near zero interest rate policy and regular asset purchases, Japanese inflation has remained negative for most of the period and therefore, has been below the 1% inflation target since 1999. In fact, inflation has crossed the 2% threshold just 9 times in the last two decades.

Source: Bloomberg, Bank of Japan

Caution about monetary policy having any impact on the Japanese inflation stems from the dismal state of credit offtake, as highlighted by the contraction in net issuance of corporate debt since late 2011, and low growth in net issuance of commercial paper (CP).  This denotes a lack of investment financing needs and according to the BOJ, CP issuance is meeting only working capital and M&A requirements. This even as the willingness of financial institutions to lend, as perceived by borrowers and measured by BOJ’s Tankan survey, is strong and increasing.

The BOJ was the pioneer of QE and has been using it ineffectively as a policy tool since early 2000s. Given the circumstances in the credit markets, unlimited asset purchase (or QE) may not create inflation either this time either. However, if the BOJ (under a new leadership) decides to include longer-dated government securities and other less liquid assets, it may prove to be a game changer. Though there is no indication of it being discussed actively as of now.

The new government also plans to undertake massive fiscal stimulus and recently, announced its intention to ignore the yen 44tn ($513bn) annual debt ceiling imposed by the previous government. However, previous doses of fiscal expansion in Japan during the 1990s were perceived to have had a minimal impact on the economy and were epitomised by the phrase “building bridges to nowhere”. Such fiscal adventurism may turn counterproductive given Japan’s large public debt. Already, yields on long-dated government bonds have started rising, threatening fiscal stability. This can also be catastrophic for large holders of government bonds like banks, insurers and pension funds.

Coming to the Japanese Yen, the domestic monetary expansion (as explained above) and a possible purchase of foreign currency bonds (or foreign exchange intervention) is expected to depreciate the value of the yen. If one looks at the history of intervention (going back to the 1980s), all successful interventions have involved coordinated international action while unilateral interventions have not yielded desired results. Given the current global macroeconomic scenario, none of the international partners will allow their currencies to appreciate. There are reports that the government may be considering creating a fund to be managed by the Ministry of Finance, along with the BOJ and private financial institutions, to help bring down the value of the yen by diversifying into international assets. Again the idea has yet to be taken up seriously and should not be taken into calculations for now.

In terms of balance of payment (BOP), while trade surplus has turned into deficit—especially due to the weak external environment and deteriorating relations with China—a stable income surplus has kept the current account in surplus. The Abe government may also start focusing back on nuclear energy, limiting the use of imported fuel, also a positive for the BOP. According to most investment bank forecasts, the current account surplus contraction has bottomed out. This too might not go in favor of a yen depreciation.

The market seems to have discounted the status of the yen as a ‘safe haven’ since issues like the fiscal cliff, debt ceiling and the Eurozone debt crisis remain unresolved. Also, its role as a funding currency in carry trades is reduced owing to low rates of US & EU. Unlimited QE by the Fed and a possible ‘currency war’ by trade competitors could play a spoilsport in any planned depreciation.

Taking a broader perspective, one must be cautious of making any long-term bets on Japan, based solely on a shift in policy. The economic policies may not be implemented fully or long enough to yield the desired results due to the unusually frequent changes in leadership and government in Japan, and the resistance to unconventional policies from the bureaucracy in both the BOJ and the Ministry of Finance. Worsening demographics too remain a negative, not just for growth, but for inflation as well.

Financial markets have already delivered their verdict on the change in power by pushing the yen to its lowest since August 2010. According to the positioning data by CFTC, net short positions on the yen have increased the most since the last week of October 2012. Also longer tenure 25 Delta risk reversals for USDJPY have turned positive, reaching their 5yr highs. Market inflationary expectations have also increased, moving up by 30-40 bps over the last three months. Even the 10s30s curve has steepened to a decade high.

We, however, believe that for the reasons discussed above, the current market moves may fizzle out once the euphoria dies down. For those who share our skepticism, it might be a good idea to take a contrarian trade and for others, a hedge is cheaply available due to the overcrowding of the ‘Abe-trade’.

 

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Changing Dynamics in the Global Steel Industry – The Trend Towards Short-term, Flexible Contracts

Posted on December 21, 2012

The global steel industry is undergoing a major structural shift in contract structures across its supply chain. This process started in March 2010, when steel manufacturers were forced by iron ore suppliers to move away from a four-decade long practice of iron ore contracts benchmarked annually to quarterly price revisions.

Specifically, iron ore miners Vale and BHP Billiton changed their annual fixed-priced contracts by negotiating short-term contracts with Asian steel mills. For Q2 2010, Vale signed iron ore contracts with Japanese steel producer Sumitomo Metal Industries at $100–$110 per metric ton. The new price was between 90–100% higher than the $60 level, which was the annual settled price for 2009–2010 between the two companies. Vale decided to move away from annual contracts for 90% of its iron ore supplies in Q2 2010. For Q2 2010, BHP Billiton secured contracts with Asian steel mills at $120 per metric ton for its Pilbara fines iron ore. This was nearly a 100% increase over the benchmark iron ore prices in Japan for the fiscal year 2009.

Experts and industry professionals across the supply chain state that the steel mills were forced to accept the changes in the contract structure. This is largely attributed to the fact that the supply of iron ore—the key raw material for steel production—is controlled by a handful of companies globally. Consequently, steel manufacturers had to accept the short-term pricing contracts and price increases.

Impact of short-term contracts on iron ore prices

With contracts being more exposed to the spot market, global iron ore prices saw a rapid rise during H1 2010. For example, Chinese iron ore prices increased by about 42% in December 2010 over the January 2010 level. This resulted in a significant increase in input costs of steel manufacturers.

However, the steel mills themselves were in a Catch-22 situation, as they could not pass the increase in input cost to steel buyers as the steel industry is highly fragmented. Steel manufacturers had to absorb a part of the increase in the cost of production during most of 2010 (except for a brief period between April and May 2010, when prices suddenly increased on speculation of negative impacts of shorter iron ore contracts).

Source: Bloomberg

The global steel industry is characterized by the presence of a large number of players and overcapacity. China alone is estimated to have more than 600 steel mills, with a large number of these having outputs less than 1 million tons/year. As of November 2012, the global steel industry has approximately 1.8 billion tons of capacity. But, total orders are likely to be about 1.5 billion tons. Despite existing oversupply in the market, producers—particularly in Vietnam, Argentina, Ecuador, Peru, and Bolivia—are planning to add capacity to the tune of 350 million tons/year.

Follow on impact of iron ore contract structures on the end-steel buyers

The short term structure of iron ore contracts and its consequent impact on raw material prices propelled steel mills to, in turn, push for short-term pricing contracts with its customers. This transition, however, has not been as smooth or as fast as in the case of iron ore contracts. This was largely attributed to the high bargaining powers of large buyers—for example, the large automotive and machinery manufacturers. For example, Volkswagen resisted short-term price revisions for its steel contracts and bought steel primarily through annual contracts until the end of 2011.

Source: Bloomberg

In August 2010, James Wainscott (CEO of AK Steel) offered the company’s customers two choices—an adjustable-price, short-term contract with relatively low prices and a fixed-rate, long-term contract with higher steel prices. Other steel mills followed similar tactics to pass on the risk of raw material price volatility to their customers.

Despite pushback by large buyers, certain steel mills, such as Arcelor-Mittal, were able to replace a large number of annual fixed-priced contracts with relatively short-term contracts. Michael Wagner, the head of Volkswagen’s treasury commodities trading, stated (in a June 2011 interview to Reuters) that due to continuous push back by steel producers, many European automotive companies had started to accept quarterly price revisions on their steel contracts by then.

Source: Platts, ArcelorMittal

 Fast forward to 2012

Since the beginning of 2012, some buyers have voluntarily turned to short-term contracts with an adjustable pricing mechanism to reap the benefits of declining steel prices. For example, in June 2012, European automotive giant, Peugeot Citroën, announced that it was considering options to move away from long-term steel contracts. The company is likely to adopt short-term contracts linked to the spot price if steel prices continue to decline. Historically, Peugeot Citroën procured steel on 6–12 month fixed-price contracts. During H1 2010, Whirlpool identified steel as a commodity that the company needed to hedge in anticipation of volatility in prices due to changes in the value chain. Whirlpool generally has a mix of short- and long-term contracts. The company’s decision to buy futures contract for hot-rolled steel coil on the New York Mercantile Exchange was a closely watched move, as many in the industry believed that steel futures were not a viable option due to its low volume.

Emerging trends in contract models since 2012

As short-term contracts gain adoption among buyers, companies are spending significant effort to derive the best pricing mechanism. A pricing mechanism that is linked to a benchmark steel price index is emerging as the preferred alternative among buyers. Here, steel prices are adjusted after a shorter interval (mostly after a quarter) based on the changes in the agreed-upon steel price index provided by a third party. Currently, CRU, MEPS, and TSI are the three widely followed indices to negotiate steel prices. CRU is the most followed index to negotiate prices in the US – industry experts claim that prices between 50–60% of the flat steel sold in the US are negotiated based on a CRU index.  MEPS and TSI are more common in Europe. The Asian steel market is yet to embrace the indexed-linked pricing mechanism.

With an index-linked pricing mechanism, steel buyers are more exposed to the volatility on the spot market. Therefore, they are increasingly looking for tools to mitigate risk of steel price volatility. This has fueled growth in the steel hedging market. For example, total volumes in the US HRC Futures contract increased from 25,000 tons/month in H1 2011 to 71,500 tons per month in H2 2011. Overall, the amount of steel being hedged in the US HRC contract increased by more than 35% YoY in 2011.

In addition to exchange-traded futures contract, steel buyers are adopting cleared over the counter (OTC) forward contracts to hedge their exposure to steel price volatility. For example, in August 2011, Swedish energy company Vattenfall hedged a large volume of steel to be used in one of its wind farm projects. The agreement involved hot-rolled coil swap based off TSI’s northern European reference price. The transaction was cleared by London-based clearing house LCH.  In addition to the steel swap contract, Vattenfall signed an index-linked physical steel contract for 150,000 tonnes of hot-rolled coil with one of its suppliers (name not disclosed), based on TSI’s daily reference prices.

What the future holds

For companies with steel spend ranging from hundreds of millions to billions of dollars, it is evident that they have been pushed to a situation where they need to be more proactive and agile than ever before.  As the spot market-linked steel pricing mechanism is likely to grow, sourcing practices are bound to change.  Steel buyers will require ever more detailed and consistent steel price forecasts, as well as qualitative, directional intelligence, to help them make informed decisions at the negotiations table.  In addition, more persistent, detailed benchmarking of sourcing practices against industry peers will be called for in order to remain at par with, if not ahead of, the competition.

Given the global financial landscape and steel industry dynamics, senior executives, decision makers, and buyers should reflect on the following regarding this industry:

  • What are the various sourcing and benchmarking practices that need to be adopted when procuring steel?
  • How volatile are steel prices going to be in 2013?
  • What is the cost-benefit assessment involved in short versus long-term contracts?
  • What strategies are large buyers adopting?
  • What is an index-linked pricing mechanism?
    • Which index is best suited for you?
    • What pricing mechanism are your competitors adopting?
  • Are you keeping a track of the various developments happening within the steel industry?
  • Are you trade customers speaking about any pricing structure or shift in contract models?
  • Have you assessed the supply chain and value chain risk involved in sourcing steel from different suppliers globally?
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The Economic Environment: Challenge or Opportunity for Procurement?

Posted on December 18, 2012

The effects of the recession and continuous economic uncertainty have caused cost cutting and cost saving to become the primary concerns for C-level executives. Tougher sales and constrained margins mean that businesses need to continuously look for opportunities to sustain top-line and bottom-line growth. This is impacting the way various functions, including procurement, are viewed within any organisation. With operational efficiency becoming a key priority, the role of procurement has gained visibility and become more strategic in many companies. According to the 2012 CFO Research Services survey of 263 senior finance executives, the procurement function at nearly 75% of respondents’ companies had become more ‘strategic minded’ over the last three years.

Over the past few years, procurement teams increasingly have been adopting a strategic approach and employing outsourcing and Total Cost of Ownership (TCO) concepts in varying degrees. Companies have outsourced non-core categories to third-party procurement service providers and benefited from the expertise of these specialised vendors as well as from more time to focus on managing core categories in-house. As procurement evaluates the TCO for various categories, Low Cost Country Sourcing (LCCS) has given way to Best Cost Country Sourcing (BCCS). Companies are looking to balance savings in product and labour costs with factors such as quality, logistics, political and currency risks, communication barriers, and protection of intellectual property when making sourcing decisions. Although several organisations are moving to a centralised procurement strategy, the focus is not on buying globally but on buying strategically based on TCO. Companies are thinking global but buying globally, regionally or locally after evaluating the best strategy for each category. The traditional savings techniques of strategic sourcing, outsourcing, and compliance have worked well for procurement so far. Leveraging combined category spend, rationalising the supplier base, applying TCO models, ensuring compliance in the business, etc., have helped procurement teams bring in cost efficiencies for a multitude of categories. However, with procurement coverage increasing and economic constraint continuing, teams need to continuously think of newer ways to optimise costs in categories, where traditional methods are already in place.

Therefore, two key questions every procurement professional will be looking to address in 2013 are:

Where does the next generation of savings really lie?

What can procurement professionals do to deliver value?

The next generation of cost-saving opportunities

Newer ways of cost savings are being developed and tested with varying intensities across various companies. The focus is largely on management at three levels—category, supplier and stakeholder. From a category perspective, the progressive next steps for procurement are to influence product design and focus on supplier sourced innovation.

In terms of supplier collaboration and improvement programs, companies increasingly need to look at the extended supply chain and not just their Tier 1 suppliers. A strong commitment to suppliers and joint identification of cost-  optimisation opportunities is needed to generate and sustain savings, as procurement can no longer rely on just identifying alternative suppliers with lower costs.

Lastly, procurement initiatives can be most successful when there is support from the business users/internal stakeholders. Getting leadership buy-in is critical to ensure that procurement transformation and strategic projects are on track and procurement is no longer viewed as a tactical support function. Teams are now focusing on working with business users to understand demand and collectively identify new opportunities. Procurement should increasingly influence buying decisions, rather than just focus on identifying suppliers and negotiating with them.

Three tools that procurement can utilise to deliver value

Market Intelligence

In this VUCA world — one that is volatile, uncertain, complex and ambiguous — up-to-date information on categories, markets, suppliers, etc. has become more valuable than ever. Many organisations have created centralised procurement intelligence teams/centres of excellence that track categories, suppliers, prices, etc. and feed information to buyers/managers in different locations. Irrespective of the procurement organisation structure and strategy (decentralised or centralised), intelligence can provide a competitive advantage and drive informed decision making.

Advanced Analytics

To effectively utilise large volumes of data from internal business users, commodity markets, etc., for driving procurement programs, a committed approach to analytics is required. For instance, commodity prices are impacted by a host of factors in different consumption centres located in various parts of the world. To manage risk associated with commodity price volatility, sophisticated forecasting skills and predictive analytics tools are needed. Similarly, advanced analytics tools are needed to assess specifications in different spend categories and reduce complexity in buying patterns.

Risk Monitoring

Mapping of risks across the supply chain and developing comprehensive risk management programs can help procurement organisations retain the value derived from cost-saving initiatives. As an example, in response to the recent Eurozone debt crisis or people revolutions in Libya and Egypt, many companies may have started monitoring risk associated with suppliers located in these countries. However, there is a bigger learning that procurement needs to take from these examples as no country or supplier is truly risk-free in today’s environment. There is merit in monitoring critical/strategic suppliers regularly irrespective of their location. Procurement also needs to develop what-if scenarios and proactively look for alternatives not only in terms of suppliers, but also in materials, sourcing models, critical markets, etc. With the help of market intelligence, advanced analytics and risk monitoring tools, as well as interventions at category, supplier and stakeholder levels, procurement professionals can look to optimise spend and achieve procurement excellence.

Given the prevalent volatile and uncertain global economy, what techniques are you adopting to propel your company’s growth? Is procurement at your organisation using the present environment as an opportunity to strengthen its position as a strategic function?

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Rejigging Manufacturing–Moving Supply Closer to Demand

Posted on December 14, 2012

The advent of globalization over the last few decades and the emergence of a ‘flatter’ world have led to Asian economies emerging as major manufacturing hubs that cater to global corporations. Across the world, companies have embraced low-cost sources to optimize costs by streamlining operations without sacrificing quality, while still serving customers in emerging markets.

However, with end markets (and consequently supply chains) becoming increasingly more complex, many organizations are beginning to look at manufacturing as a core enabler of overall competitive advantage. Specifically, in looking at alternative manufacturing strategies to enable greater agility in catering to evolving customer expectations, many manufacturers are looking to closely match supply locations with demand locations by leveraging onshoring or nearshoring manufacturing strategies.

To elaborate, many factors are prompting companies to re-evaluate their manufacturing footprint to stay competitive. These include:

  • Disruption risk in the supply chain
  • Currency risks
  • Quality maintenance
  • Geopolitical fissures
  • Long lead times
  • Fuel price volatility
  • Rising labor costs
  • Technological advancements

Although offshoring is still expected to play an important role within the manufacturing paradigm, it is evident that a company’s total manufacturing strategy will need re-thinking to accommodate the additional context of demand location. This new trend of moving more of the supply closer to demand appears to be resonating across industries as shown in the following chart.

Company

Change Implemented

Year

Lenovo

 Plans to build all its Think-brand PCs for the US   market at its facility in Whitsett, North Carolina, to meet the demands of   its customers in the US

2012

Nissan

 Announced that it would shift production from   Japan to localized manufacturing in Tennessee, on account of a serious   concern regarding the strength of the yen

2012

General   Electric

 Moved its appliance manufacturing back from   Mexico and China to Kentucky, US, at an estimated investment of $1 billion,   to be closer to demand centers

2012

Google

 Announced that its new wireless home media   player, the Nexus Q, is being manufactured in the US (near its headquarters   in California) to speed up innovation and lead time

2012

Airbus

 Announced plans for a $600 million production   facility in Alabama, its first assembly plant in the US, to cater to its   growing single-aisle aircraft market in the US

2012

Caterpillar

 Announced plans to move its manufacturing base from   Japan to facilities in Georgia, US, barring high-tech components

2012

Toyota

 Announced the expansion of its plant in Indiana,   US, to support the Highlander range, in a bid to implement a localization   strategy to align manufacturing location with demand

2012

Dow

 Announced investments in excess of $4 billion to expand   its gas-based chemical manufacturing in Houston, Louisiana, and Texas—to   capitalize on low gas prices in the US

2012

Exxon   Mobil

 Announced plans to build factories to produce   ethylene and plastics in Texas, US, to leverage low gas prices—providing a   cost advantage over oil-based production in Europe and Asia

2012

Peerless   Industries

 Consolidated all manufacturing of audio-visual   mounting systems in Illinois, US, moving work from China in order to achieve   cost efficiencies, shorter lead times, and local control over manufacturing processes

2012

Whirlpool

 Moved the production of KitchenAid hand mixers,   which for the past six years was being manufactured by a contractor in   Huizhou, China

2011

Samsung

 Transferred its European production unit to   Poland by acquiring the washing machine and refrigeration production plants   from Amica, a Polish company

2011

Saint-Gobain

 Announced plans to open a solar mirror   manufacturing facility in Goodyear, in view of US-based customers   requirements

2011

LG

 Selected Poland for its new washing machine   production line, with an annual capacity of 700,000 units. It plans to further   increase its refrigerator capacity in Poland by 2012 to better serve both the   European and North African markets

2011

Sleek Audio

 Moved the production of its high-end headphones   from suppliers in Dongguan, China, to its plant in Florida, US, to take   advantage of faster lead times and greater product control

2011

Fagor

 Gradually relocating its European production   plants to Poland from its French center; also plans to start a dishwasher   line

2011

Electrolux

 Announced the location of its new cooking   products factory at Tennessee. It plans to leverage the location not only for   North American operations (but for its cooking facilities worldwide)

2011

Ashland

 Announced investments to expand its facility in   Virginia, US, after having considered investments in China and Europe

2011

BMW

 Invested $250 million to develop its headquarters   in New Jersey and create two new regional distribution centers to cater to   North American customers

2010

Siemens   Energy

 Opened a 450,000-square-foot Gas Turbine   production plant adjacent to its existing Steam Turbine-Generator   manufacturing plant in Charlotte, North Carolina, to expand its manufacturing   footprint in the US

2010

Low-cost country sourcing: On the Decline?

Since the mid-1990s, many corporations have been outsourcing or offshoring all or a part of their manufacturing operations. This was largely attributed to the availability of low labor costs as well as cheap oil, which made long supply chains viable and economically feasible. Companies focused on reducing manufacturing costs through three major strategies:

  • Offshoring/outsourcing models
  • Rationalizing plants (leveraging economies of scale)
  • Consolidating distribution centers and warehouses

Indeed, Low-Cost Country Sourcing (LCCS) has become a manufacturing imperative in recent decades.  However, the prolonged worldwide economic downturn since 2008 and fears of a double-dip recession have had a significant downward impact on how companies visualize and adopt global sourcing strategies. Looking at the numbers, exports from low-cost countries sharply dropped during the crisis—from $3.8 trillion in 2008 to $3.0 trillion in 2009—and are yet to recover to their pre-downturn levels.  Companies are also increasingly rethinking their LCCS strategy on account of myriad problems, ranging from commodity price volatility, currency risks, product recalls, quality adherence issues, to rising labor and input costs, among others.

Additional Strategies

This is not to suggest that LCCS faces an imminent threat of becoming outmoded, but rather that business models are also increasingly evolving to accommodate multiple strategies, including Best-Cost Country Sourcing (BCCS). One can look to obtain similar cost savings by adopting either realigning manufacturing or strategic sourcing strategies. The chart below gives us an approximate estimate of the total cost savings potential by process for a given company.

Source: AT Kearney

Evolving from LCCS, best-cost country sourcing (BCCS) evaluates a range of factors besides just labor costs – in line with the increasing trend of companies increasingly looking to build a more strategic approach to manufacturing, including building portfolios of supply sources and seeking to achieve total competitive advantage rather than pure-cost reduction.

Companies are increasingly seeing less expensive manufacturing costs offset by a rise in transportation and logistics costs. As a result, companies are increasingly evaluating ways to move more manufacturing and sourcing processes and systems onshore (or near shore).  (The Boston Consulting Group reported in April that one-third of American companies with revenue greater than $1 billion were either planning or considering to move their manufacturing base back to the US.)

Manufacturing closer to the customer allows for improved flexibility to respond to unplanned spikes or slumps in demand and customer requests—in an agile and efficient way, with swift delivery times—while maintaining quality and optimized costs.

The decision to opt for such a shift in strategy needs to be determined by analyzing the total cost. This includes a host of parameters, including unit cost, input cost, transportation cost, inventory, warehousing and handling cost, duties, taxes, and financing cost.  This concept—known as the total landed cost—is an efficient way to calculate the cost of manufacturing in one location and serving customers in other locations. In such an assessment, the impact and cost advantages of low-production costs are generally offset by an increase in transportation costs.

Correlation between manufacturing location and revenue

The company’s manufacturing location plays a very critical role in determining the total revenue of the company. According to a study undertaken by Accenture, for large companies (with a significant share of revenue outside the US), supply exhibits a strong correlation with demand. In the US, for companies with revenues more than $10 billion, about 50% of supply manufacturing comes from the US. However, if we compare current revenue and regional manufacturing allocation with the 2013 projections, growth in revenue (consequently demand) and manufacturing supply are likely to shift to emerging regions such as Asia and Latin America, while North America’s and Western Europe’s shares are expected to be moderate.

The rising significance of regional manufacturing strategies

Globally, manufacturing is experiencing an upheaval, driven by increasing labor cost in developing countries, changing demand scenarios, rising volatility in markets, geopolitical tensions, and escalating oil prices. These factors are in turn compelling manufacturers to reassess their business models and revamp their supply chains.

These are likely to result in major shifts in how and where goods are manufactured. The other ancillary, but equally important consideration include local tax policy and incentives, devaluation of various currencies, availability of the right talent and domestic political pressure. The primary need of the hour for various global companies is the realignment of manufacturing locations and regional hubs are likely to gain greater prominence in the near future.

For a company operating primarily in the US or Western Europe, it could translate into establishing or extending the scope of operations to Mexico or Eastern Europe. It is also likely to result in optimal manufacturing strategies, which would include the cost of materials, demand patterns, and product distribution. Senior executives will need to cautiously monitor these dynamics, and anticipate and tackle the ongoing transformations to suitably tweak manufacturing and logistics solutions.

Amidst the rapidly changing market dynamics, companies need to evaluate whether demand-centric manufacturing strategies will better serve customer needs and expectations. Also, as more global intricacies come into play, a flexible sourcing roadmap is likely to gain utmost importance to enable organizations to succeed in the fast-evolving market place.

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Crowdfunding: An Alternate Financing Model?

Posted on December 11, 2012

Crowdfunding (CF) can become an alternate medium of financing for those who have been refused financing from banks or venture capitalists.

CF, also referred to as ‘peer-to-peer lending (P2P),’ is a method of raising funds from different people through the Internet. The funds are raised to support a particular initiative, which could be an invention, a social or creative project, or a business venture. Further, an investor may or may not receive a financial return by investing through Crowdfunding. Crowdfunding can be categorized into donation-based, reward-based, lending-based, and equity-based funding.

Some of the leading crowd-funding platforms (CFPs) are as follows:

Type
Major CFPs
Amount Raised
($ millions)
CFP Fee
Expected Return
Focus Segments
Lending
LendingClub
993
1.1–5%
About 70% investors earning 6–12% return
(as stated on November 8, 2012)
Individuals seeking loans for credit card pay off, debt consolidation, home improvement, etc.
Lending
Prosper
365
0.5–4.95%
Average: 9.69%
(as stated on November 26, 2012)
Individuals seeking funds for debt consolidation, starting a business, etc.
Donation/Reward
Kickstarter
400
5%
-
Individuals, groups, or organizations seeking funds for movies, documentaries, music albums, etc.
Donation/Reward
indiegogo
15
4%
-
Individuals and businesses with campaigns categorized under creative, entrepreneurial and cause categories
Donation/Reward
RocketHub
2
4%
-
Individuals, groups, or businesses seeking funds under categories, such as entertainment, politics, and comics
Equity
crowdcube
7
5%
Average: 16%
(as stated on October 16, 2012)
Businesses seeking funds for seed capital, expansion etc
Equity
wefunder
27*
5–7%
NA**
start-ups, and existing businesses
 *The amount mentioned is the total pledged by investors and not invested
**NA means Not Available

 

The CF sphere is currently dominated by donation-based funding—CF began through this form of lending.However, the share of equity-based CF is expected to increase in the future, due to its legalization in the US. CFs will be regulated as per the JOBS Act that was signed on April 5, 2012; and the Securities Exchange Commission (SEC) is expected to come out with the detailed guidelines by early 2013, i.e., 270 days after the signing of the act.

CFPs perception as an alternate financing option

In an opinion poll conducted by Real Business in 2012, about 51% of the respondents felt that CFPs could be an alternate source of finance for small businesses. The possible growth in CFPs for small businesses or other donation-based campaigns will depend on the following:

  • The legal framework of various countries, which must support CF
  • CFPs, which must stick to small loans and not enter into commercial banking territory
  • The quality of the campaigns/projects, which must be screened to ensure low default rate

The amount raised and the number of CFPs have increased at a very high rate. In 2011, the total amount raised through CFPs increased about 72% over 2010. Further, this number is estimated to grow by 90% to $2.8 billion by the end of 2012, as compared to 2011.

3 E refers to estimated value

CFPs as an alternate financing option is gradually becoming popular for primarily three types of needs—small business loans, personal loans, and entertainment and creative projects.

Last resort for small and new businesses?

CFPs are gradually acting as a new medium to obtain finance for small and new businesses; thereby, reducing their dependency on banks, venture capitalists and loan sharks.The following are some indicators that can be attributed to the growing prominence of CF among small businesses:

  • In the UK, between January 2010 and September 2012, almost 40% of small businesses were denied loans
  • In the US, the Federal Reserve conducted a study in late 2010, of the debt demand of US small businesses. Of the 27 million small businesses in the US that needed traditional capital, 23% never applied, for the fear of rejection. Of those who did apply, they were turned down 51% of the time

Thus, banks inability or interest to service small business loans—especially post-recession, is a strong driver for growing popularity for CFPs. The key resons for banks’ disinterest in this segment are:

  1. Startups are a risky proposition, as their failure rate is very high.
  2. It is less rewarding to grant a small loan, as the time and effort needed to process a loan is not directly proportional to the amount of the loan.

Source: ‘Crowdfunding Industry REport’, Massolution (May 2012); ‘Small Business Lending in the United States 2010-2011′, U.S. SBA (July 2012)

In terms of growth in small business loans, while Lending Club (a prominent lending-based CFP) experienced a significant increase over the last three years (as highlighted from the adjacent graph) in 2010 and 2011, the overall growth for small business loans in the US registered a consistent decline.

Source: ‘Crowdfunding Industry REport’, Massolution (May 2012); ‘Small Business Lending in the United States 2010-2011′, U.S. SBA (July 2012)

Another interesting insight is that CF operates in a different targeted loan segment (i.e., very small business loans).The chart on the left clearly indicates the sphere where CFPs can survive. Startups and small businesses can make use of CFPs for smaller, short-term loans.In 2011, in the US, loans less than $250,000 accounted for $243 billion. If CFPs can tap even 10% of this share, it will mean a $24 billion market for equity-based and lending-based CF in the US alone.

Entertainment and creative fields: role of CFPs

Ambitious entertainment and creative projects often face financing problems, as their success is not guaranteed—another reason why donation-based or reward-based CFPs are gaining popularity as a source of finance for such groups. CF is the way forward for the lower end of the entertainment industry, which finds it difficult to finance its work—be it music shows or comic strips, CFPs serve the dual purpose of providing finance and measuring the popularity of their work. Further, banks are not the best evaluators of a work of art, while CFPs allow people to assess each campaign and invest in what they like.The following are some examples of creative projects being funded through CFPs:

  • In India, a national, award-winning movie, “I AM”, raised around $3 million through CF in 2010.
  • In 2009, film-maker Franny Armstrong raised about $2.5 million through CF for her film, “The Age of Stupid,” which was on climate change.
  • ‘I Am Verity’ raised $80,000 from 2,000 fans in 25 countries to release an album and donate to women’s charities in South Africa.
  • As of November 2012, music, films and art made up almost 65% of the funds raised by Kickstarter.

Personal loans: another target segment for CFPs

Lending-based platforms also publish campaigns by people for personal loans; for purposes such as debt consolidation, credit card payoff, and home improvement. Almost 73% of loans issued through Lending Club are used for debt consolidation and credit card pay off. This could be another segment that can offer opportunity for CFPs.

CFPs – the way forward

CF can emerge as a great source for those projects that are not eligible for small loans or do not receive the adequate funds from banks.  Although the market is naive at present, the ease of entry in this segment might lead to a rapid growth in the number of CFPs. Further, as CFPs lack differentiation, it might result in lower volumes per CFP across the sector.

Another key concern could be the default rate for equity and lending based CFPs— while Lending Club gives the rate of default in payment as 3%, Kickstarter and Indiegogo have reported zero cases of fraud until 2011. As the number of CFPs and campaigns increases, the quality of campaigns might get diluted. This might make investors apprehensive of investing in CF.

To tap the potential of CF and facilitate its healthy growth, it is necessary that the CF sector be positively regulated and dealt on par with other financing vehicles.

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The Impending Patent Cliff: Reversal of Fortune or Future Opportunity?

Posted on December 6, 2012
The 2012 Great Patent Cliff

Product innovation has always been critical to pharmaceutical company growth. Extensive new product developments during the past three decades have made innovation second nature to this industry. High research and development (R&D) investments and product launches were important parameters that defined the success of pharmaceutical companies during this period—the most important achievements being the blockbuster drugs that significantly increased revenue and provided industry leaders with a significant competitive advantage.

As these blockbuster drugs reach the end of their patent lives, pharmaceutical companies are reaching an impasse. Prepare for the worst or strategize a way out? The question leaves many to wonder what pharmaceutical companies can do when these blockbuster drug patents expire and generic competition looms in the shadows.

The impending “patent cliff” being touted by the media and various industry blogs is definitely at the forefront of the pharmaceutical industry’s list of challenges. No doubt 2012 to 2015 will be a difficult period for an industry already being pressured from insurers and governments to keep prices down along with increased regulatory vigilance.

So amongst all this doom and gloom, where is the bright spot?

Today, lifecycle management has become critical for the continued growth of pharmaceutical companies. Charting a comprehensive lifecycle management strategy (pre-launch, peak and maturity) to harvest financial and clinical rewards has proved successful for companies such as Eli Lilly, EnhanceRx, and Pfizer. However, most pharmaceutical companies fail to respond to lifecycle planning requirements until the product enters the last stages of its patented life. In our whitepaper on this topic, we look at how an early lifecycle management strategy is helping companies successfully implement its other strategies and provide case studies on how companies are adopting an early lifecycle management approach.

The way out

Despite what may seem to be a bleak outlook for pharmaceutical companies, those that identify and embrace a proactive approach towards product lifecycle management are weathering the storm. A proactive lifecycle management approach can help companies innovate around molecule structure, delivery methods and auxiliary uses of blockbuster drugs as well as retain customers post-patent expiry, keeping revenues afloat. Organizations should work closely with pharmaceutical scientists and patent attorneys to strategize and maximize the period of market exclusivity of their intellectual offspring as well as look at ways to change market dynamics by integrating the value chain and product lifecycle with the patient and physician.

To read more on this topic, request our complimentary whitepaper.

 

 

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The Smart Cube Risk Appetite Index – The Tale of Two Asset Classes: Equity and Fixed Income

Posted on December 4, 2012
This is the third installment of The Smart Cube’s monthly Risk Appetite Index (TSC RAI) blog series.
 

For the first time in more than 50 years, UK pension funds hold more bonds than equities. In fact, many fund managers are now raking up more bonds in their portfolios. According to JPMorgan, around $2 trillion has flowed into fixed-income, with equities receiving only $400 billion of global investment. Even as the S&P 500 has risen by 9.8% this year, equity funds are still recording outflows. Some people have referred to this as death of the cult of equity.

Critics of those flocking toward bonds say that bond investors are up for shocks. The yields have declined to the levels not seen since the 1950s; therefore, investors may incur capital losses if interest rates begin to rise. Further, an environment of inflation may erode any yields. For the risk bonds offer, returns are rather low. Moreover, short-term perspective and fear have inflated the price of assets across the fixed-income markets.

Proponents of bonds, however, do not believe that interest rates will rise soon. Further, supply–demand imbalance bolsters the case of bonds, and is one of the reasons for negative yields in core European countries such as Germany, where demand for Bunds has increased after the EU crisis. Even in the US, bonds issued during the debt boom before the financial crisis are maturing, and net new supply is low.

Reversal is Coming – But When?

As the global economy rebounds, inflation will rise, in turn, leading to higher interest rates. Further Central banks may also start selling the bonds they have been buying through quantitative easing and monetary measures. Consequently, the money which has piled into the sector will flow out of it. Most fund managers believe that they can get out before others when the market will take such a turn, but timing for such reversals have been extremely difficult in the past.

Figure 1. Risk Appetite: Fixed Income vs. Equity

Figure 1. Risk Appetite: Fixed Income vs. Equity

Using The Smart Cube’s RAI to Track Market Sentiments

One of the ways in which fund managers can feel the change of winds is by closely observing the risk appetite for equity and bonds. They can do so using TSC’s RAI to better understand when market participants will switch from equities to bonds, and vice versa. The RAI (created by The Smart Cube) is a new index developed to measure the appetite for risk in the global financial system. Using a basket of variously weighted inputs, adjusted regularly to track importance, TSC’s RAI can be used to aid investment decision making, generating trading signals and financial analytics.

The RAI is composed of six sub-indices of volatility, commodity, equity, fixed income, currency and credit. Each sub-index represents the risk appetite prevailing in that asset class. In this article, we have used the equity and bond sub-indices to compare the sentiments of these two classes.

Timing Portfolio Transition Using TSC’s RAI

Figure 1 shows the risk sentiment in the equity and bond markets using TSC’s RAI equity and fixed income sub-indices. Additionally, it classifies the history into three periods—Bond preference (blue zones), Equity preference (red zones), and Neutral preference (green zones, where both bonds and equity share similar risk perception).

The data shows that sentiments change after a period of sustained neutral preference. In the current risk scenario, equity risk appetite seems to be lagging fixed income risk appetite by quite a bit. However, a bit of technical analysis shows that chances of a neutral preference among investors are quite likely in the next year. Keeping a close watch on the sentiment reversal in the next year can prove to be quite crucial for any investor who may want to perfect his timing out of the fixed income portfolio to equity.

For more on TSC’s RAI performance and outlook, view our recent update.

More about TSC’s RAI 

For a methodology brief of TSC RAI, request our white paper.

Current values of TSC’s RAI will be available in future blog posts along with thought-provoking insights. If you would like to receive current values more  frequently or would like the historical series, email insights@thesmartcube.com or contact your local Smart Cube office.

Previous Posts

Second Installment – Tactical Investing

First Installment – Introducing The Smart Cube RAI

 
 

 

 

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The Widening Scope of Spend Analysis: Procurement to Finance

Posted on November 27, 2012

Spend analysis is the process of collecting, cleansing, classifying, enriching, and analyzing expenditure data. In the past, spend analysis was primarily conducted to analyze procurement spend. However, of late, because of its many benefits, the process is increasingly being leveraged by corporate finance departments for processes such as budgeting, margin improvements, cash management, forecasting saving opportunities, and aligning spend and financial requirements. According to a study conducted by Aberdeen Group (published in March 2010), 86 percent of finance departments consider spend analysis to be a high-value tool, whereas 12 percent consider it to be of moderate value.

Differences between Procurement and Finance Spend Analysis

The operational approach adopted by procurement and finance departments differs. Procurement is a cyclic process, which under normal business conditions is carried out on a regular basis. Financial activities can be classified as cyclic and non-cyclic. Financial processes, such as budgeting, managing cash flows, regulatory compliances (tax, security markets), transactional information, and communication of financial statistics, are carried out at specific intervals and require a deep understanding of the company’s spend. Non-cyclic activities could include M&As and dividends pay-out.

Finance Spend Analysis Scenarios

For cyclic financial processes, such as budgeting, a company normally operates on two models—operating budget (focused on profitability) and cash-flow budget (focused on the cash-flow dynamics). Spend analysis plays an important role in both these models, as it presents a clear picture of the operating expenses and helps in maintaining cash reserves by predicting expenditure and saving opportunities. This helps in forecasting and setting the profitability targets and budget allocation. In addition, companies can utilize it to pull out data to compare category costs against allocated budgets.

Non-cyclic financial activities are primarily dependent on the availability of funds. Further, allocation/availability of funds is driven by cost savings, margin improvements, etc., which can be made more efficient and effective through a transparent and exhaustive spend analysis program.

According to a study by Aberdeen Group (published in March 2010), globally, 75 percent of CFOs reported being under immense pressure while forecasting saving opportunities, 63 percent reported prioritization of top-spend categories, and 38 percent believe that they are under pressure to bolster bottom-line growth. Hence, CFOs could leverage advanced spend analysis tools to efficiently manage pressure and identify effective solutions to address their concerns. Additionally, spend analysis has allowed finance personnel to visualize opportunities of greater savings through reduction of external expenses rather than internal cost-saving initiatives (such as budget reduction or staff decrease). This helps boost workplace morale and enhance employee productivity.

According to another study by Science Warehouse and e-World Purchasing and Supply, in 2012, the demand for advanced spend analytics tools has risen across procurement and finance departments. Nearly 30 percent of respondents reported a requirement for greater financial control, 26 percent cited that tools provide the ability to effectively analyze spend, and nearly 23 percent reported the need to closely manage cash flow. Also, enterprises leveraging automated spend analysis processes have reported a 30 percent higher rate of cost savings, compared to enterprises utilizing manual analysis methods.

Following are some examples that highlight the positive impact spend analysis programs are having on finance departments:

  • Cendant Corporation, a US-based business/consumer services provider primarily into real estate and travel businesses, benefited by implementing Silver Oak Solutions’ spend analysis program, as it reduced the company’s financial control units from 20 to 8. In addition, the tool provides monthly feeds of financial data, which helps ensure efficient operational performance of the company
  • A large publisher saved $1.2 million in invoice processing costs through American Express’ spend analysis program. The money saved along with the reforms helped strengthen the company’s cash flow and refine its budget planning
  • Owens Corning, a US-based glass fiber manufacturer, was able to achieve cost savings by implementing the spend analysis solution provided by Emptoris. This helped the company to achieve better profit margins.

With intensifying competition and rising needs for cost optimization, spend analysis is increasingly becoming an important tool across departments (from procurement to finance).

How can spend analysis help your finance function achieve cost optimization benefits? Are there other departments where spend analysis tools can be implemented within your organization?

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Social Media Electrified! Innovative Applications by the Power Utility Sector to Conserve Energy

Posted on November 15, 2012

The use of social media has grown considerably in the last few years, with a host of organizations in the power utility sector increasingly recognizing the impact of social media on their marketing, communication, and business strategies. According to Pike Research, a staggering 624 million customers worldwide are expected to use social media to connect with utility companies by 2017.

While power utilities  increasingly are using social media services to communicate with end-users on issues pertaining to changes in pricing, billing, addressing customer concerns, and launching new services, some organizations are developing innovative applications that utilize social media platforms as an endeavor toward sustainable development.

OPower, a customer engagement platform provider for the utility sector, along with 16 power utility companies, partnered with Facebook and National Resources Defense Council to launch an online application. The application leverages the Facebook platform and allows users to benchmark their energy usage with their friends, participate in energy conserving competitions, and share tips to increase energy efficiency.

Social media usage by the power utility sector is currently believed to be just the tip of the iceberg. According to Opower’s Director of Corporate Marketing, Eric Fleming, “With 98% of the US online population using social media for a whopping one out of every five minutes spent online, there’s a tremendous opportunity for utilities to engage their customers in new ways. To put this in perspective, on average, Accenture has found that people only spend about 6 minutes interacting with their utility each year.”

Similarly, Welectricity, a startup, also offers a free service platform to assist residential users to track and reduce their electricity consumption. Residents can enter their electricity bill information into the platform and generate a graphic dashboard, which can then be compared with that of other households. The platform allows users to invite friends and relatives to join their network, and engage in a friendly competition to reduce energy consumption. Accounts on Welectricty can also be connected to users’ Facebook and Twitter accounts, so that their energy efficiency achievements can be shared across their extended social network.

Both OPower and Welectricity are utilizing social media platforms to tap one of the most fundamental human impulses—competition. They have used gaming concepts to help consumers understand the impact of their daily behavior by providing tools to track and compare energy use with their peers.

Utility companies are also trying to woo customers through interesting applications. ConEdison, a utility company in New York City, has launched Power of Green, an iPhone application that has more than 100 illustrated tips and videos to conserve energy. Similarly, San Diego Gas & Electric rolled out a platform, ‘Green Button Connect My Data’, with the launch of their first application PowerTools, developed for web browsers. The application provides information on customers’ energy consumption and its related environmental impact, along with improvement measures. The company plans to launch the application for mobile phones as well as third-party platforms, such as Facebook.

A few technology device manufacturers are also harnessing the opportunity. Tenrehte, a New York-based company, has developed a smart plug known as PICOwatt, which monitors and measures the energy use of an individual device, and relays the generated information over a Wi-Fi network. The smart plug can be accessed from any Internet-enabled device through a smart phone application or Facebook.

With competition among utilities intensifying and consumers becoming more aware, there will be an increasing demand for real-time interaction between consumers and utilities, and social media will play an important role to help achieve this goal.

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Treading the Path of Developed Economies: Paradigm Shift in Indian Healthcare

Posted on November 13, 2012

In October 2012, the Health Ministry of India announced its plans to ban branded drugs to curtail the rising cost of healthcare and promote healthcare affordability. This is closely on the lines of the Obama administration’s Affordable Care Act (ACA), 2010. Under this directive, all pharmaceutical companies are required to submit generic names in place of brands to apply for a license to manufacture fixed dose combinations (FDC). Also, doctors in the public sector have been directed to prescribe generics instead of branded drugs. The amendment is part of a series of reforms, such as expanding the essential drug list from 74 to 348 in 2011, Market Based Pricing for essential drugs, and foreign direct investment in medical insurance, by the ministry.

On average, about 86 percent of the total healthcare expenditure in India is out-of-pocket, compared to 25 percent in the US. Out of this, nearly 72 percent is spent on medicines (largely on branded drugs). As per industry standards, a generic drug is expected to cost between 80–85 percent less than a branded drug. Looking at the cost difference, this move by the Indian health ministry is focused on reducing the out of pocket costs amongst consumers.

While this reform is expected to increase the affordability of healthcare, it does pose challenges for the industry overall, such as quality control, implementation, and industry acceptance, which will likely impact the success of these reforms.

Ensuring the quality of generics will be the greatest challenge for the government. The US has a well-tested and implemented quality control system, executed through the FDA and CDC. However, in India, clinical trial violations are more the norm than the exception.

In August 2012, the Central Drugs Standard Control Organization (CDSCO) was charged with approving at least 33 new drugs without any clinical trials. Also, on an average, the Drug Controller General of India (DCGI) approves at least one drug (mostly generic) every month, without any clinical trial. A ban on branded drugs will therefore erode the quality offered by brands and leave patients at the mercy of undifferentiated generics.

In the absence of across the board quality measures and subsequent strict implementation, the Indian healthcare market may face a torrent of sub-standard medicines, reduced R&D investments and expenditure, and value erosion.

Also, the $20 billion Indian pharmaceutical industry could suffer unprecedented losses due to these reforms. With more than 5,000 players, this sector is the largest exporter of branded generics and has almost two-thirds of its exports directed to highly regulated markets, such as the US and Europe. Any restriction on brands may restrict its current annual growth rate of 17 percent, and the industry’s exports may fall short of the expected $25 billion revenues by 2015.

Furthermore, between January and September 2012, the BSE Health index (17 leading companies) registered a growth of 28 percent—outperforming the Sensex, which registered a growth of 21 percent. The impressive performance of this sector is primarily attributed to the high valuations paid/formulated by investors/buyers for companies such as Ranbaxy Laboratories, Piramal Healthcare, and Paras Pharma. In fact, the acquisition of Ranbaxy by Daiichi was highly motivated by the latter’s intention to enter the branded generics market.

The introduction of new laws, however, may not allow companies to charge royalty or brand-value on their drugs, which will lead to value erosion in the already competitive drug market. Large conglomerates will face stiff competition from private labels, which may prompt them to relinquish key cost heads, such as R&D, to ensure their sustainability (in terms of price competition).

Even in the US, the ACA reforms were supported by government initiatives, such as improving market access to pharmaceutical companies through increased medical coverage, to help companies write-off losses on value by volume. However, in India, healthcare coverage penetration lags by approximately 15 percent, with virtually no future promotion plans by the government.

Due to factors such as a ban on branded drugs, limited access to the market, and poor medical coverage penetration, not only will the sector run dry, but could make investors lose money on their investments.

In addition, the promotion of generics by developed economies (the US and Europe)—now being replicated by emerging markets (India)—could jeopardize the sustainability of research-based pharmaceutical companies.

These arguments prompt us to wonder what the implications will be of the government’s support for generics, and, in its tug-of war with brands, the impact on innovation versus duplication.

 

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Response Modeling in Loyalty Analytics

Posted on November 9, 2012

Statistics indicate that consumer participation in reward programs is on the rise across all demographic segments. What can retailers do to ensure campaigns effectively incentivize customers and maximize ROI? Incorporating response modeling into targeting efforts could prove useful.

Loyalty programs allow retailers to analyze and influence customers’ shopping behavior, understand trends, and reward loyal customers. The data gathered through loyalty programs helps retailers communicate with their customers in a customized manner and maximize marketing ROI. Customers are incentivized to buy more from the same retailer, which also inculcates a sense of loyalty.

The transactional and demographic data is utilized to drive customer loyalty through targeted campaigns that run across different marketing channels, such as direct mail, e-mail, and coupon at till. For example, a campaign could be run to incentivize existing customers to buy a higher variant of a particular product (typically called up-selling).

The key to running a successful campaign is to be able to correctly segment customers and make offers based on customer behavior and profile. Retailers do this in many ways—they enroll customers in different tiers with a customer getting to sign-up on less premium tiers and upgrading to the high premium tiers when he or she exhibits a particular buying behavior. This segregation is typically based on perceived ROI. Another way to segment customers is to use past transactional patterns along with customer demographics. Retailers leverage these segments and tiers to design a customer-specific promotional marketing suite that delivers personalized offers.

As stated above, the targeting rules for these campaigns are often based on spending patterns and demographic profiles, and generally do not account for one critical variable—i.e., a customer’s propensity to respond to a particular campaign. This is where response modeling comes into the picture.  In response modeling, a predictive model is built that separates the likely responders from the non-responders by using one of the many predictive modeling techniques. Retailers face two major challenges while applying response models to loyalty data. Firstly, the nature of products can vary significantly. For instance, the response to a soft drink campaign may be different from the response to a shaving cream campaign. Secondly, there may not be an adequate number of campaigns for a particular kind of product to build an accurate and robust response model. To address these issues, the below-mentioned two-stage modeling process—which combines regression and logistic regression techniques—can be adopted:

Stage 1: Overall regression model

An overall regression model is built to capture a customer’s response to all campaigns over a specified period of time. The dependent variable in this model is the number of responses to a particular marketing campaign. Thereafter, an equation is derived on the basis of variables that have a significant impact on response rates. This equation is then applied to each customer to understand his or her overall propensity to respond. An overall score for each customer is calculated, which represents his or her likelihood to respond to a marketing campaign. Customers are then sorted based on this score.

Stage 2: Aisle-level logistic regression

To address issues related to variability of products and a limited number of campaigns in a category (commonly called aisle), logistic regression models are built for each aisle. For instance, models are built for detergents, fabric softeners, soft drinks, etc. The dependent variable in these models is coded as if a customer has responded to even a single campaign in that particular category and if he or she has not. Since the models are built for each aisle, it would account for product variations. In addition, since the model is logistic, even a single campaign is enough to build the model (although the model may not be robust if the number of campaigns is low). Using this model, a probability score is calculated for each customer for every category in which he or she has responded. This probability represents the customer’s propensity to respond to a campaign in that particular category.

The objective of this two-stage process is to derive a set of probability scores for each customer. There would be an overall score and a list of aisle-specific scores for each customer. So, if a marketing campaign is to be run for an aisle, where we already have a contact history, the aisle-level scores would be used, and if we have a campaign for a niche product that falls in a category for which no campaign has been run previously, the overall scores would be used.

These scores would help the retailer preferentially select customers for any marketing campaign, for any product.

So what does this mean for retailers?

As a retailer, one has to be aware of the diverse techniques that can be used to evaluate the successful outcome of a loyalty campaigns and understand the intricate details involved in in consumer behavior patterns.

Given the fascinating and rapidly evolving consumer dynamics, what are the various techniques you are adopting to study the impact of a loyalty campaigns and ensure its successful outcome? How can response modeling assist you in maximizing ROI?

 

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The Smart Cube Risk Appetite Index – Tactical Investing

Posted on November 8, 2012
This is the second installment of The Smart Cube’s monthly Risk Appetite Index (TSC RAI) blog series. 
 
 

The current macroeconomic environment—dominated by low yields and tail-risk concerns (US fiscal cliff, Euro crisis and China slowdown)—has challenged investors of all types. While some fund managers have become more tactical in their asset allocations, others have started reviewing risks more frequently.

It is no longer a question of active versus passive investing, but of how to combine the best of both approaches in blending strategies, according to Blackrock. In this blog, we explore risk-based allocations, which can help portfolio managers further their goal of tactical investing.

Using TSC RAI for tactical, risk-based allocation

Risk-based allocation is one of the popular forms of active investing. Risk-based allocation strategies do not depend on subjective future expectations and can be blended well with passive strategies. However, these strategies require a robust measure of risk.

TSC RAI measures the appetite for risk in the global financial system using a basket of variously measured inputs—adjusted regularly to track importance. TSC RAI can be used to aid investment decision making, generating trading signals and financial analytics (Introducing The Smart Cube Risk Appetite Index RAI).

Tactical investing using TSC RAI

To show the benefits of tactical investing using TSC RAI, we take the basic case of equity versus bond allocation. We begin with the conventional strategy involving 60 percent equity and 40 percent bond (60–40 strategy) and compare it to tactical strategy using TSC RAI.

In tactical investing, we overweigh the equity component in contrast to the bond component during higher risk appetite in the market, and vise versa during the period of risk aversion. We use z-score of the TSC RAI to classify periods into risk appetite and risk aversion.

Tactial Asset Allocation vs. Traditional (60/40)

Benefits of tactical investing

We see that the tactical portfolio allocation based on the RAI offers returns that exhibit lower volatility and lower drawdowns. Therefore, tactical asset allocation could prove to be a winning strategy in the long run.

For more on TSC’s RAI performance and outlook, view our November Update.

More about TSC RAI  

For a methodology brief of TSC RAI, request our white paper.

Current values of TSC’s RAI will be available in future blog posts along with thought-provoking insights. If you would like to receive current values more  frequently or would like the historical series, email insights@thesmartcube.com or contact your local Smart Cube office.

 

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Survey Analytics – The Elusive Key Drivers

Posted on November 5, 2012

To maintain and improve brand visibility, it is critical for companies to measure and monitor customer satisfaction at regular intervals. This is primarily done through customer surveys, which are administered through pen and paper, over the telephone, or over the Internet. The key analysis of this data includes evaluation of overall customer satisfaction level, and customers’ likelihood to recommend a particular product/brand.

Generally, overall customer satisfaction/recommendation is driven by more granular attributes of a product. This may include specific product features, service quality, or product pricing. The objective of key driver analysis is to evaluate these parameters and identify which of these are important in driving overall customer satisfaction, and their relative importance in doing so. The reduced set of relevant and important attributes are called key drivers of customer satisfaction/recommendation.

Application of Key Drivers

Key driver analysis is required to identify discrete, actionable parameters affecting overall customer satisfaction/recommendation. This helps companies relate actionable product attributes to overall customer satisfaction. As a follow up to identifying the relative importance of each attribute, respective average satisfaction levels are also mapped to arrive at an “importance-satisfaction” matrix. This matrix can help identify key action areas—parameters with high importance, but low satisfaction levels.

 Identification of Key Drivers

There are several approaches to identifying key drivers, ranging from simple cross tabulation to advanced techniques of supervised learning. Broadly, the following two methods are used to identify key drivers:

When time is not a constraint for analysis, it may be a good idea to use both these methods, to build a more reliable and accurate model.

Conventional Statistics

Conventional statistical techniques range from basic cross tabulation to advanced regression modeling. Best practices indicate that techniques specific to ordinal scale should be used in survey analytics because of the nature of the data. Usually, regression-based analysis is used to identify these key drivers. However, additional techniques such as decision trees can be used to complement or validate results from regression models. Ideally, multiple techniques should be used to identify the best method and cross validate the results.

Parameter reduction techniques are required to ensure that we feed the right variables and do not overload the regression model. One of the common statistical techniques used for this is factor analysis, which combines related product attributes into relevant factors. Each factor can then be subsequently used in the regression analysis.

Neural Networks

In addition to conventional statistical methods, neural networks are sometimes used in survey analytics. Artificial neural networks (ANN) employ mathematical models to imitate functionality of human body’s nervous system. The biggest advantage of using neural networks is that they can replicate any kind of mathematical relationship, and can usually provide more accurate results. This gives them an edge over conventional statistical procedures, most of which rely on strict rules and assumptions.

However, interpretation of results from such techniques is usually not as straightforward as that in conventional statistics, specifically in terms of estimating relative importance of driving variables. This is due to the relatively black-box, and often complex, computing involved in neural networks. While neural networks may not replace conventional methods in survey analytics, they can be used to improve and validate results from conventional statistical techniques.

Conclusion

Identification of key drivers of customer satisfaction or of a customers’ likelihood to recommend a product/brand can lead to significant benefits for an organization. This gives them a peek into the minds of consumers, and provides them with very direct and actionable product attributes. Addressing customer issues across these key drivers can help companies to achieve higher customer satisfaction.

However, while conducting such analyses, one should take into account the distinct nature of the survey data. It is important to use the right techniques (based on ordinal data) and validate the findings by exploring non-conventional methods such as artificial neural networks.

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Changing Dynamics in the Shipping Industry and the Impact on Procurement

Posted on October 19, 2012

Nearly 10% of product costs are attributable to shipping. As such, the shipping industry is playing a significant role both from a cost as well as supply security perspective. Yet, what we have found is that this has been a relatively low focus for procurement executives.

Gautam Singh, co-founder and CEO of The Smart Cube, discusses the insights he will share during his presentation at the Procurement Leaders Forum in Vienna on 24 October 2012 in a short video Q&A.

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Introducing The Smart Cube Risk Appetite Index (RAI)

Posted on October 11, 2012

The Smart Cube (TSC) recently developed a new index to measure the appetite for risk in the global financial system. Using a basket of variously weighted inputs, adjusted regularly to track importance, TSC’s Risk Appetite Index (RAI) can be used to aid investment decision making, generating trading signals and financial analytics.

TSC’s RAI tracks market moves

The relationship between the performance of various assets and the risk appetite has become stronger since the recent financial crisis, with asset price movements closely tracking risk appetite, rather than economic fundamentals. The relationship between RAI and different assets* can be seen in Chart 1. It shows that RAI effectively represents risk appetite and broadly maps asset price movements.

 Chart 1

Sources: Bloomberg, The Smart Cube


RAI as benchmark for price levels

RAI tracks asset price movements, and can also be used as a benchmark to compare levels. As Chart 3 shows, there have been three other periods since the crisis when RAI has stood near the levels where it stands today. Given that risk has played a dominant role in driving valuations since the crisis, one can expect the price levels to be broadly similar for the same levels of risk appetite. To test this proposition, TSC plotted the average prices of five major assets/indices during four periods as outlined in Chart 3, which produced the following result.

 Chart 2

Charts 2 and 3 underpin RAI’s effectiveness as a benchmark to measure risk and track various assets in financial markets. This property can be exploited to make better trading calls or for various analytical purposes—from relative analyses to regression modelling. These themes will be further explored in our forthcoming blogs.

Is there more appetite for risk? 

The risk appetite over the past year has been very volatile and has been oscillating between risk-off and risk-on almost unnoticeably. TSC RAI does a very good job of mapping risk appetite and is therefore a very useful tool in such uncertain times. As can be seen from chart 3, after hitting the bottom in early June this year, RAI has been on a consistent rise, and recently, it reached a new 30-month high. Monetary stimulus on both sides of the Atlantic, in terms of QE3 in the US and bond purchase in the Eurozone, should help RAI rise further. The prospect of a new risk rally has significant implications for all asset classes, and the relationships illustrated in Chart 1 can help investors plan for the coming months.

 Chart 3

 Sources: Bloomberg, The Smart Cube, Federal Reserve
*Composition of baskets:
EM FX – INR, BRL, TRY, MXN, ZAR, RUB; Equity – S&P 500, STOXX, MSCI Emerging Market; Credit- JPM EMBI, ITRAXX

More about TSC RAI  

For a methodology brief of TSC RAI, please refer to our white paper.

Latest values of Risk Index will be available in the forthcoming blogs along with some interesting insights. If you would like to get the current values more  frequently or would like the historical series, please  email insights@thesmartcube.com or contact your local Smart Cube office.

 

 

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Emerging Supply Chain Risks in the Pharma Industry: Why Must This Issue be Addressed?

Posted on October 8, 2012

Logistics accounts for 45–55% share of the value chain of a drug. Tied in with associated complexities around sourcing and manufacturing, supply chain management (effective or otherwise) clearly has a strong bearing on the total cost of a drug. Players in the pharmaceutical space, therefore, are undertaking a range of strategic initiatives to reduce cost across all phases of the pharmaceutical supply chain. These range from sourcing raw materials outside of a company’s home country to outsourcing and joint ventures and partnerships.

Along with these new strategies, come new risks, such as counterfeiting, which has resulted in costly product recalls; regulatory-compliance-related risks, which many executives consider to be second only to counterfeiting; and distribution delays, which could cost companies millions of dollars in lost sales. Pharmaceutical companies, therefore, need to identify and implement new strategies and processes, supported by new technologies, to aggressively reduce and manage the new challenges they may face.

The Smart Cube recently wrote an article on pharmaceutical supply chain management, which included seven proposed solutions to managing or mitigating the risk that these new strategies present. They include:

  • Greater collaboration
  • Better integration
  • Technological enhancements
  • Packaging solutions
  • Balancing the trade-off between low-cost and low-risk
  • Strategic sourcing and supplier relationship management
  • Flexible and adaptable supply chains

Supply chains will play a major role in their ability to adapt, consolidate or refocus their core business segments. Therefore, pharmaceutical companies will need to institute the right supply chain configuration and adaptability, by using internal, external and country-specific resources to create best practice-based supply chains, and to overcome supply chain obstacles in a constantly changing global environment.

What is your company doing to manage or mitigate supply chain risk?

For more on this topic, view “Pharmaceutical Supply Chain Risk Management”.

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Special Purpose Acquisition Companies: Key Parameters Investors Should Assess at Various Investment Phases

Posted on September 27, 2012

Special Purpose Acquisition CompaniesHedge funds and institutional investors have been investing in numerous vehicles that are unavailable to retail investors, such as private equity investment options. Special Purpose Acquisition Companies (SPACs) is an option that allows all secondary market investors to participate in a PE-type investment scheme, largely reverse merger or Leveraged Buy-out (LBO) transactions.

Historically known as blank check/penny stock companies, these investments traded actively on exchanges during the 1980s. Subsequently, this instrument started being used for business manipulation and scams followed suit. In 1990, the SEC enacted the Penny Stock Reform Act (PSRA), which put an end to the fraudulent activities. The blank check companies returned to markets in the form of SPACs in 2003 with stricter regulations to ensure better investor protection. Since 2003, the concept has become a known investment medium and has developed at a steady pace.

Although SPACs provide numerous benefits, investors should follow certain key parameters while making decisions at various investment phases—at the time of an IPO, during a target search, after target spotting (up for voting), and post-acquisition.

A recent SPACs article published by The Smart Cube includes a flowchart that walks investors through the SPAC process. The article also highlights the benefits for an investor in this instrument. However, investors are cautioned that the assessment of SPACs should be done while keeping in mind that the very basic nature of this investment has important risks that should be evaluated due to various stages of uncertainties and lack of transparency.

Read the full article here.

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