Supply & Demand Chain Executive - Special Edition - September 2015

TOOLS FOR ACHIEVING COST SAVINGS: Cost Analyzer p.11 September 2015

Global Solutions for Supply Chain ROI

HOW TO

CAPITALIZE ON FALLING COMMODITY PRICES OUTLOOK

Buyers’ Outlook p.5 The Commodity

SUPERCYCLE p.9 INSIGHTS REVEALED

Manufacturing in Cambodia p.17 Supply Chain Risk p.20

Industry information and expertise… from microchips to cargo ships.

Every decision matters.

That’s why leaders around the world rely on IHS to help them make the best choices.

As the premier provider of global market, industry and technical expertise, we understand the rigor that goes into decisions of great importance. We scale our thinking across virtually any operation or enterprise, from ground level tactics to high level strategy to match the scope of our customers’ needs.

IHS… when decisions matter

IHS.com

5054_0314PB

table of contents

SPECIAL EDITION: September 2015

Volume 16

INSIDE 4 Executive Memo

The Economy Still is Wobbling Special edition provides tips on how to thrive by leveraging falling commodity prices to achieve cost savings.

5 Buyers’ Outlook

IHS’ Commodity Price Outlook: Buyers’ market remains for most commodities.

9 Commodity Outlook

Lessons from the Fading Commodity Supercycle Prices of raw materials have plummeted, signaling the end of a 15-year commodity boom. The implications for countries and businesses are far reaching.

SPECIAL EDITION

How to Capitalize on Falling Commodity Prices

11 Cost Savings Toolkit Toolkit Review:

Get the cost savings you deserve.

13 Price Mechanisms

In this special issue of Supply & Demand Chain Executive, we’ll update you on today’s commodities market. Global information and analytics firm IHS says that, despite the grim economic news from Greece and, most recently, China, we’re not headed for a global recession.

Commodity prices, however, will remain flat for at least the remainder of this decade. In this issue, we’ll provide some tips on how to survive.

Common Challenges for Contract Price Mechanisms Five price data pitfalls to avoid when linking price data to contracts... and how to avoid them.

15 The Energy Supply Chain Case Study

Energy Supply Chain Transformation

17 Manufactuing in Cambodia

Is Cambodia the Next Big Contestant

in Low-cost Manufacturing?

The country reflects broader changes in Asia’s manufacturing landscape and the ever intensifying search for low-cost manufacturing opportunities.

IHS Contributors Farid Abolfathi, Senior Director, Country Risk John Anton, Senior Principal Economist, Steel

20 Supply Chain Risk

Toby Colquhoun, Senior Analyst, Technology

Strategic and Operational Risks in the Auto Industry

Laura Hodges, Director, Price Forecasting David Hunt, Senior Analyst, Country Risk Jason Kaplan, Senior Manager, Price Forecasting Ryland Maltsbarger, Principal Economist, Agriculture

A case study focused on Brazil, Argentian and Mexico evaluating some of the integrated data and analytics tools for teams involved in the selection and management of global supply chains.

John Mothersole, Research Director, Price Forecasting Jola Pasku, Economist, Country Risk Howard Rappaport, Senior Director, Chemicals Paul Robinson, Senior Economist, Price Forecasting Katie Tamblin, Director, Supply Chain Solutions

Special Edition/September 2015 Supply & Demand Chain Executive

3

SPECIAL EDITION / September 2015

executive memo

®

The Economy Still is Wobbling

W

hile we’ve emerged from the financial disaster of 2007-08, we’re still dealing with a fragile, volatile global economy. The commodities arena is no exception. Global information and analytics firm IHS keeps a close eye on all areas that affect business operations in almost any industry you can think of.

In this special issue of Supply & Demand Chain Executive, we’ll update you on today’s commodities market, including lessons learned from what IHS calls the fading commodity “supercycle” and China’s role in that fade. Also, we will demonstrate how lower commodities prices means significant cost savings for buyers globally.

Here’s just a taste of what you’ll learn.

The IHS Materials Price Index (MPI) has been in decline all year. In August, it was down nearly 20 percent from where it was when 2015 started. And it was almost 50 percent lower than in summer of 2014. Much of this is due to China, where industrial activity showed little if any growth in the first half of this year and markets have been in turmoil.

The news isn’t all bad, though. According the Englewood, CO-based IHS, “we are not facing a global recession at this time. However, as unnerving news from Greece and China has dominated the headlines over the summer period, it is easy to overlook recent economic reports pointing to a gradually accelerating global recovery. Real GDP growth in the United States is accelerating on consumer spending growth. Across the pond, despite slightly disappointing second quarter growth figures for the Eurozone, low oil prices, a weak euro, European Central Bank (ECB) stimulus, and increased consumer spending continue to shape our outlook for Europe.”

Since I began by talking about commodi-

Barry Hochfelder

Editor Supply & Demand Chain Executive barry.hochfelder@sdcexec.com 4

Special edition provides tips on how to thrive by leveraging falling commodity prices to achieve cost savings. ties, let’s take a look at what’s ahead for a few of them, according to the research.

■C hemicals. Feedstock prices have tumbled, especially in Asia, pushing chemical and plastic prices down. A lack of supply-demand pressure points to lackluster prospects for price increases in the near future.

■S teel. This is a buyers’ market and should remain so for the year, although prices should trend upward over the second half of the year, “but they are down so far that a modest rally still means levels will be very low. Watch for trade actions that could add duties to your imports,” IHS warns.

■N on-ferrous (base) metals. Data indicate that prices will remain fairly flat for the foreseeable future. Sluggish growth in emerging market demand and a tighter U.S. monetary policy that dampens investor interest will offset a general improvement in conditions as global growth slowly improves.

IHS believes commodity prices more-thanlikely are near bottom. Prices are approaching production costs for many commodities, establishing a temporary floor under prices.

Also, while the global economy’s expansion has been lackluster, “we do see a slow improvement in growth ahead, which should provide some degree of demand support.”

The company expects any recovery in prices to be fairly slow over the coming quarters, especially since it believes that China’s economy will slip down further in 2016.

“The odds are that commodity prices will remain relatively flat, rather than recover strongly, for at least several years. IHS believes commodity prices will not regain their early 2014 levels for the rest of this decade.”

For a deeper look at commodities, and much more, please enjoy this special issue of Supply & Demand Chain Executive. ■

Supply & Demand Chain Executive Special Edition/September 2015

Global Solutions for Supply Chain ROI

www.SDCExec.com Published by AC Business Media Inc.

201 N. Main Street, Fort Atkinson, WI 53538 (800) 538-5544 • www.ACBusinessMedia.com

Print and Digital Staff Publisher Jolene Gulley Editor Barry Hochfelder Associate Editor Carrie Mantey Assistant Editor Eric Sacharski Art Director Kayla Brown Ad Production Manager Cindy Rusch Sr. Audience Development Manager Wendy Chady Audience Development Manager Tammy Steller Advertising Sales (800) 547-7377 Jolene Gulley, jgulley@ACBusinessMedia.com Stephanie Papp, spapp@ACBusinessMedia.com Editorial Advisory Board Lora Cecere, Founder and CEO, Supply Chain Insights Tim Feemster, President, Foremost Quality Logistics John M. Hill, Board of Governors, Material Handing Industry of America Rory King, Director, IHS William L. Michels, CEO, Aripart Consulting Julie Murphree, Founding Editor, Supply & Demand Chain Executive Andrew K. Reese, Former Editor, Supply & Demand Chain Executive Bob Rudzki, President, Greybeard Advisors Raj Sharma, CEO, Censeo Consulting Group Kate Vitasek, Founder, Supply Chain Visions Circulation & Subscriptions P.O. Box 3605, Northbrook, IL 60065-3605 (877) 201-3915, Fax: (800) 543-5055 Email: circ.sdcexec@omeda.com List Rental Elizabeth Jackson, Merit Direct LLC (847) 492-1350, ext. 18, Fax: (847) 492-0085 Email: ejackson@meritdirect.com Reprint Services Jolene Gulley, jgulley@ACBusinessMedia.com AC Business Media Inc. Chairman Anil Narang President and CEO Carl Wistreich Executive Vice President Kris Flitcroft CFO JoAnn Breuchel VP Content Greg Udelhofen VP Marketing Debbie George Digital Operations Manager Nick Raether Digital Sales Manager Monique Terrazas Published and copyrighted 2015 by AC Business Media Inc. All rights reserved. No part of this publication may be reproduced or transmitted in any form or by any means, electronic or mechanical, including photocopy, recording or any information storage or retrieval system, without written permission from the publisher.

Supply & Demand Chain Executive [USPS #024-012 and ISSN 1548-3142 (print) and ISSN 1948-5654 (online)] is published five times a year: March, May, June, September and December by AC Business Media Inc., 201 N. Main Street, Fort Atkinson, WI 53538. Periodicals postage paid at Fort Atkinson, Wisconsin and additional entry offices. POSTMASTER: Please send all changes of address to Supply & Demand Chain Executive, P.O. Box 3605, Northbrook, IL 60065-3605. Printed in the USA. SUBSCRIPTION POLICY: Individual subscriptions are available without charge in the United States, Canada and Mexico to qualified individuals.

Publisher reserves right to reject nonqualified subscribers. Oneyear subscription to nonqualified individuals: U.S., $30; Canada and Mexico, $50; and $75 for all other countries (payable in U.S. funds, drawn from U.S. bank). Single copies available (prepaid only) for $10 each. Return undeliverable Canadian addresses to: Supply & Demand Chain Executive, P.O. Box 25542, London, ON N6C 6B2.

The information presented in this edition of Supply & Demand Chain Executive is believed to be a­ccurate. The p­ublisher cannot assume responsibility for the validity of claims or p­ erformances of items appearing in editorial presentations or advertisements in the publication.

buyers’ outlook

IHS’ Commodity Price Outlook:

Buyers’ Market Remains for Most Commodities

T

he IHS Materials Price rate hike act to support the dollar, the Chinese economy. However, as Index (MPI) continued to adding further downward pressure unnerving news from Greece and decline in the first half of to commodity prices. The Brent oil China has dominated the headlines 2015. In August, the MPI price decline confirms the near-term over the summer period, it is easy was at its lowest level for outlook of weak oil fundamentals as to overlook recent economic reports the year: more than 10 percent below world markets continue to remain pointing to a gradually improving where it was in January 2015 and oversupplied with high storage levels. global recovery. Real GDP growth almost 50 percent below where it was These impacts are driving chemical in the United States is accelerating COMMODITY PRICE WATCH / AUGUST 2015 in summer 2014. Prices collectively prices down as well. Metals remain on consumer spending growth.

Across the pond, despite mildly are now back to levels last seen in a buyers’ market. Prices for most Leverage Gauge disappointing second quarter growth mid-2009. Low commodity prices products are expected to rise only for the Eurozone, low oil prices, a have triggered “bargain hunting” in slightly in the coming months. weak euro, European Central Bank some markets, although aggregate demand continues to look lackluster.

Key growth assumptions (ECB) stimulus, and increased Weakness is expected to persist for the The bursting of the Chinese stock consumer spending continue to rest of year, as China’s devaluation of market bubble has overshadowed support modest expansion in Europe. downward pressure, as yuan’s devaluation the yuanCommodities and a looming U.S.facing interest additional signs of modest improvement in

and the expected US interest rate hike add further support to the dollar.

Figure 1: Leverage Gauge

Buyers

Commodities facing additional downward pressure, as yuan’s devaluation and the expected US interest rate hike add further support to the dollar.

Neutral

Sellers Special Edition/September 2015 Supply & Demand Chain Executive 5

Ethylene

buyers’ outlook Energy

COMMODITY PRICE WATCH / AUGUST 2015

Chemicals

Steel

Nonferrous

Tumbling feedstock prices and growing production anchor bearish tone Figure 2: Ethylene Buying Environment

Buying Environment Next Quarter (2015Q4)

Same

Next Year (2016)

Worse

Prices to hit trough soon 60 55 50 45 40 35 30

2012

2013

2014

2015

2016

drivers. As more capacity comes as automotive and household the United States utilizing appliances. As a result of weak propane asdemand a feedstock, which as will most converters reduced + Ethylene is growing, consumersdemand, look to stockpile offer producers an increasingly lowproduction rates. They also decided Supply cost position, prices are expected to keep inventories lean amid - toAremain numbersubdued. of crackers units continuous long supply. The outlook In and Asia,production spot resumed operations from their earlier propylene pricesthis have dropped in for late summer/early autumn maintenances summer accordance with the fluctuating stock - With a light turnaround season next quarter,remains weak. Buyers are expected to supplyin willChina remain strong market and soft outside energy of a majorremain cautious about replenishing unplanned event prices. Somewhat tight supply—as inventory in anticipation of a further Prices a result of ongoing production unit price correction on the back of • Prices have fallen sharply in recent weeks, with maintenances and some unplanned volatile energy and feedstock costs. little upside potential in the short term. Expect downward price pressures to remain through the crude oil prices and increased outages—had kept prices from falling Falling fall. further over the summer; however, an supply in the region will continue to increase in supply due to production place downward pressure on prices if restarts and new capacity will keep there3 are no unplanned disruptions downward pressure on prices. affecting production.

Bottom line: Now would be a good time to buy Prices are sliding on the back of and restock inventories, weak crude oil prices and healthy although with the risk to the price outlook on the ethylene prodcution levels. downside, the window of Polypropylene: strong demand opportunity should remain for the in the first half of the year, thanks near- to medium-term. to a precipitous drop in propylene monomers, has put producers in Steel a position to continue to push for The weakness in China has taken margin; however, IHS does not prices to levels not seen in a decade. foresee a price increase for August, For other regions, we expect a muted but more likely is an increase in recovery for the second half of 2015, September. Production in June was with prices remaining low overall.

5.3 percent higher than June 2014, Sheet: Sheet markets are trying to Chinese Steel and while production growth remains digest recent anti-dumping filings in Energy Chemicals strong in late summer, it is still not Europe and North America. Europe keeping pace with strong sales. As Prices at levels not s Figure 3: Chinese Steel Buying Environment a result, June inventories declined, reducing days of inventory to the Buying Environment Dema lowest number we have seen. We Same Next Quarter (2015Q4) - The expect the inventory number to fall pers even lower for late summer, with the have Worse Next Year (2016) term market continuing to be very tight. indic In Asia, the decrease in spot Suppl Market remains weak polypropylene (PP) imports for July - Cap 900 was driven by tumbling feedstock stee 800 man values, long supply, and sluggish large 700 downstream demand. Buying 600 + Call as s momentum slowed in July on the 500 cash 400 back of poor domestic demand Prices 300 from downstream sectors, such 2012 2013 2014 2015 2016 2017 Demand online in

2017

Ethylene, cents/lb, North America

© 2015 IHS

Chemicals Ethylene: North American & Asian spot prices have tumbled. Prices are sliding on the back of weak crude oil prices and healthy ethylene production levels. At the same time, the bearishness seen in the Chinese stock market, as well as skittishness in Europe around the latest Greek debt negotiations, had affected sentiments in the commodities market, with buying interest weakening significantly. With a light turnaround season this fall there is little upside risk to the current forecast outside of a major unplanned event.

Polyethylene: PE producers have delayed contract price increases to late summer or early autumn, as buyers push for contract price concessions. Rising inventory levels and strong production should press against proposed increases. Thus, any price increase would be based on regional effects from supply conditions in Europe and logistical constraints around the Gulf Coast.

Propylene: Spot prices for North American propylene reached their lowest levels since 2009 in July.

Competitive feedstock costs, fiveyear high inventory levels, and weakening crude oil prices are the major current propylene price

Hot-rolled sheet, dollars/metric ton, China Cold-rolled sheet, dollars/metric ton, China

6 Supply & Demand Chain Executive Special Edition/September 2015

© 2015 IHS

• Pric in a are

buyers’ outlook moved first, but now the United States has filed against all three products—hot rolled, cold rolled, and coated (including galvanized). These actions will boost prices somewhat, but we expect domestic mills to increase production as imports are excluded. Added domestic tonnage limits the upside potential for prices.

If European and American domestic mills do not increase tonnage then there is upside risk, but that is extremely unlikely based on available capacity and the history of prior antidumping cases and company reaction.

The price differential between the United States and other countries has widened once again. The gap is sustainable over the short run as antidumping limits arbitrage equalization between high and low price regions. But eventually buyers will find ways around the trade actions, or consumers in the United States will cut production because of being simply uncompetitive. By late 2016, prices in the United States are likely to suffer mild declines as global prices try to equalize.

Plate: Prices still show increases for the second half of 2015 and across 2016, but the rate and the level are muted. Asian prices are extremely low, deep into loss-making territory.

If NAFTA countries do go forward with anti-dumping actions, then their prices will be revised upwards and Asian prices revised downwards.

There are rumors of an anti-dumping filing against plate, but it is quite speculative so it is not built into our current forecast.

Structurals: The trough for structurals is expected in late summer/early autumn. A very weak rally should take hold for the latter part of 2015. Costs and the need for profitability argue for sizeable increases, but demand from global construction is weak with outright

declines in China. Chinese prices are much lower than in Europe, while European prices are much lower than in North America.

Steel pipe: Pipe prices remain on a downward trend, as weak demand and falling raw material costs make finding a price floor a moving target.

Trade restrictions filed on sheet products also complicate the picture, but there is little to suggest prices will find an impetus to rise beyond where

asserting itself as the driver of base metals prices. China has been the dominant influence in the market for some time, but in January and early July it was events in China and on the Shanghai Futures Exchange— not the London Metal Exchange (LME)—where price formation was found to be taking place. To be sure, LME settlement prices continue to be referenced as the daily measure of market movement, but now these moves are coming more and more frequently in Steel is a buyers’ market and will direct reaction to what is happening in China. This remain so for most of 2015. Prices is not really a surprise; it should trend upwards over the has been a change in the second half of the year, but they are making for more than down so far that a modest rally still 20 years as China’s share in global consumption means levels will be very low. has grown, but the baton was formally passed only they are now for the rest of the year, this year when events in China due to the large amount of inventory demonstrated unequivocally that they overhanging the market. Special bar do not just influence prices, but cause quality: Special bar quality (SBQ) them. prices are declining once again.

Aluminum: As recently as six months Falling energy demand is outweighing ago the market was expected to strong automotive consumption. record a deficit, which provided some Some capacity is being idled but it is support to prices, but conditions not enough to prevent price declines. have changed. Transactions prices It can be argued that declines were (LME+premiums) fell well below overdue since other products had cost, and therefore to unsustainable been falling for several years, along levels, in July and remained there with scrap and ore input costs. We in August, There are two problems do not expect a rout, but there is toward achieving higher prices, remaining downside room. however: Chinese production and Bottom line: Steel is a buyers’ global inventory. For this reason we market and will remain so for most expect additional production cuts in of 2015. Prices should trend upwards the very near future. These cuts will over the second half of the year, but support some sort of lift to prices. they are down so far that a modest This said, LME prices struggle to rally still means levels will be very clear $1,700/metric ton until early low. Watch for trade actions that 2016 and are not projected to clear could add duties to your imports. $2,000/metric ton until late 2017.

Copper: Prices saw a sharp Nonferrous metals correction in early summer. The The first half of 2015 will be intriguing question for the copper remembered for China finally market is now what happens to Special Edition/September 2015 Supply & Demand Chain Executive 7

buyers’ Copper

outlook

Energy

COMMODITY PRICE WATCH / AUGUST 2015

Chemicals

Steel

Nonferrous

Production costs continue to move lower Figure 4: Copper Buying Environment

Buying Environment Next Quarter (2015Q4)

Worse

Next Year (2016)

Worse

Forecast has been lowered 8,500 8,000 7,500 7,000 6,500 6,000 5,500 5,000

2012

2013

2014

2015

2016

2017

Copper, dollars/metric ton

© 2015 IHS

the metal in China attached to so-called stock financing. This was metal imported over the past two years but not linked to physical use.

There is evidence to suggest that these imports, a classic carry trade, were related to domestic and foreign interest rate differentials.

Buying Strategy

While copper looks fundamentally technology, but also below the cost of balanced this year, which should be much of traditional sources of nickel.

Demand supportive of prices, the potential The excessive stocks and a step- return Globalofconsumption expected in in demand from the stainless inventory held in theto grow by 3.0% down 2015, down from the 7.3% increase recorded last bonded warehouse zone around year and the weakest number since 2011 market means there is little reason the carry tradecontinues unwindsto for prices to recover sharply. So, - Shanghai Chinese as industrial activity underwhelm could undercut prices. while prices are well + Bargain hunting has increased Balancing off these into the industry’s Supply two opposing sets of Overall, base metal cost-curve, we see forces hasdrop the in forecast + Recent prices has resulted in further prices are near expected prices recovering production cuts, which will keep the market looking range bound only slightly before balance this year to remain fairly flat the end of 2015, over the next six Prices quarters. for the foreseeable and see slow upward • While range-bound view of pricing over the nearNickel: Pricesthe forecast forfuture. movement through term remains, the remainder of the year has been lowered to account for weakness in have fallen again, 2017. prices during July and August dipping below the Bottom line: cost of production for the majority Overall, base metal prices are 6 of producers. Prices have failed to expected to remain fairly flat for the find a bottom and instead continued foreseeable future. Sluggish emerging to track down over the summer, market demand growth and tighter reaching lows not seen since the worst U.S. monetary policy that dampens of the economic crisis, and more investor interest in commodities COMMODITY WATCH / AUGUST 2015 likely to be found in 2003 than the should offset aPRICE general improvement current decade. These levels were not in conditions as global growth slowly only below the cost of production accelerates. ■ of the high-cost nickel pig iron

Figure 5: Buying Strategy Overview

Category

Buying Strategy

Chemicals

Buy As Needed

Softening energy prices shaping short-term outlook

Plastics

Buy As Needed

Supply bottlenecks in a number of markets have eased

Carbon Steel

Buy Now

Prices to begin to rebound modestly from very low current levels

Stainless Steel

Buy Now

Nickel prices to recover gradually

Nonferrous Metals

Buy Now

Recent drop in prices will spur cuts in production, which will lift prices

Precious Metals

Buy As Needed

Price environment on firmer footing compared to recent months

Equipment

Buy As Needed

Buying environment remains favorable

© 2015 IHS

8 Supply & Demand Chain Executive Special Edition/September 2015

Notes

7

commodity outlook

Lessons from the Fading Commodity Supercycle

By Farid Abolfathi, John Anton and John Mothersole

Prices of raw materials—crude oil included— have plummeted, signaling the end of a 15-year commodity boom.

The implications for countries and businesses are far reaching.

T

he past 12 months have seen a precipitous drop in many primary commodity prices. Crude oil prices have collapsed, with the price of Brent crude falling from well over $100 per barrel last year to less than $60 earlier this year. Likewise, iron ore prices declined from around $95/ metric ton to below $50, and rubber prices tumbled from nearly $2/pound to less than $1.60. Collectively, commodity prices, as measured by the IHS Material Price Index (MPI), have fallen by more than 40 percent since July 2014.

Last year’s commodity crash was not totally unexpected since prices of most commodities had been receding for some years already. The speed of the decline for many commodities, however, took most traders by surprise. The IHS MPI, a weighted average of weekly input spot prices for the manufacturing sector, went into a near-free fall during the second half of

Figure 1 : The 15-year commodity supercycle has run its course IHS weekly Material Price Index (MPI), 1996-2015 (2002:w1 - 1.00)

2014. The index had in fact been on a downward path for the prior four years, after having hit its cyclical peak in late April 2011. Since then, despite periodic short-term rebounds, it has generally been trending down and currently stands more than 53 percent below its 2011 peak. IHS believes that the past decade’s commodity boom is over.

China’s role in the current supercycle While we can blame easy monetary conditions for facilitating the last decade’s commodity supercycle, its key driver was the rapid economic expansion of emerging markets during most of the past two decades.

In particular, it was China’s dizzying pace of growth that underpinned the rapid rise of energy and raw material prices. Moreover, it was China’s insatiable appetite for energy, raw materials, and other goods that enabled other developing countries to sustain robust growth for the past two decades. In short, China’s soaring demand for everything from iron ore to oil and gold was the dominant driver of the supercycle (see figure 2).

It is worth noting that China’s ascension to the World Trade Organization (WTO) in 2002 was a watershed event, without which the supercycle might not have been possible. At a minimum, the cycle’s amplitude and duration would probably have been far smaller.

WTO membership not only boosted tremendously China’s exports

Special Edition/September 2015 Supply & Demand Chain Executive 9

commodity outlook China's percentage share of global consump5on of selected major primary commodi5es China's percentage share of global consump5on of selected major primary commodi5es

Figure 2: China’s percentage share of global consumption of selected major primary commodities 70

70 60 60 50 50 40 40 30 30 20 20 10 10 0 0

*Iron ore *Iron ore

Cement Cement 2002 2002

Copper Copper

to the rest of the world, but also attracted huge volumes of foreign direct investment (FDI) into the country’s manufacturing sectors.

These, in turn, led to vast amounts of domestic capital being invested in precisely those industries that are intense users of energy and raw materials. The domestic investment binge, which was easily financed by Chinese people’s excessive savings, generated an insatiable appetite for energy and raw materials during the last decade. Indeed, not only did levels of physical consumption of commodities rise, but the rate of their growth also accelerated. It was this acceleration that started to strain commodity markets and pushed prices progressively higher—far above previous nominal cyclical peaks.

Commodity prices roughly doubled between 2002 and 2004. They doubled again between 2004 and early 2008, before crashing during the Great Recession’s global credit crunch.

China’s 2008 crash proved remarkably brief, though. The Chinese authorities’ implementation of an aggressive economic stimulus package in response to the Great Recession in late 2008 triggered a frenzied capital spending boom that in turn drove demand for many raw materials sky-high, pushing prices to unsustainable levels once again.

For instance, the price of iron ore at China’s Tianjin port climbed to

*Aluminum *Aluminum 2014 2014

Zinc Zinc

Crude oil Crude oil

about $200/ton by February 2011, nearly seven times higher than its average during the preceding decade.

Even though the vastly elevated price levels were not supported by market fundamentals, for many commodities the boom was sustained by what analysts sometimes refer to as “mania,” or psychological factors. But eventually the day of reckoning did arrive. As China’s economic growth decelerated over the last several years, broad-based commodity price indices ran out of steam. The IHS MPI, along with other commodity price indices, started to sag in 2011—slowly at first, but steadily. The gradual downward trend continued for about two and half years, before culminating in last year’s crash. Even though prices seem to have stabilized somewhat recently, they would likely further decline if China’s economy further decelerated.

What’s next?

IHS contends that most prices have fallen sufficiently for the market to at least find short-term price stability near their current levels. Indeed, when measured in most major currencies, commodity prices have probably already hit bottom.

There are two reasons why further declines will likely be limited: 1. For many commodities, prices are approaching production costs, placing at least a temporary floor under prices.

10 Supply & Demand Chain Executive Special Edition/September 2015

2. While the global economy’s expansion has been lackluster over the past several years, we do see slow improvement in growth ahead, which should provide some degree of demand support.

So what do these mean for commodity prices? IHS expects any recovery to be fairly muted over the coming quarters, particularly since we believe that China’s economy is set to edge down further in 2016. As a result, excess production capacity in many sectors should constrain price increases in most commodity markets for at least another year. For some commodities, such as iron ore and aluminum, abundant capacity will likely keep prices under downward pressure for some years.

The history of past supercycles suggests that a disorderly price correction, such as the one we have witnessed the past 12 months, usually is followed by a long period of relatively weak pricing power and underinvestment in commodity markets. After a powerful boom usually comes a long, painful bust that discourages investment, but eventually sets up the markets for the next commodity boom and sometimes a supercycle. So the odds are that commodity prices will remain relatively flat for at least several years.

Indeed, IHS believes commodity prices will not regain their early-2014 levels for the rest of this decade. After an initial short-term cyclical rebound, real prices might slowly drift higher, but they are likely to remain far below their 2014 levels even by 2025. ■ About the Authors: Farid Abolfathi is senior director, Economic Risk, IHS Economics and Country Risk.

John Anton is senior principal economist, with IHS Operational Excellence and Risk Management.

John Mothersole is research director, Pricing and Purchasing, with IHS Operational Excellence and Risk Management.

cost savings toolkit

Toolkit Review: Get the Cost Savings

YOU DESERVE The Impact of Commodity Prices on Your Procurement Practices After years of reaching peak after peak, commodity prices have suffered through their sharpest decline since the global economic recession and are now back to their 2005 levels. Now companies must set about the task of clawing back the cost increases that have plagued procurement

“Many organizations are struggling to answer the question: ‘Are we aiming high enough for cost savings in 2015?’”

believed that prices would increase this year. Just 18 percent of respondents foresaw prices falling, and of those, the expected decline was just 4.6 percent. As we have already seen, many categories have fallen to greater depths, and, as declines whip through supply chains, the savings will be felt across a broad set of categories. This suggests that many purchasing managers are ill-equipped to capture appropriate cost savings in today’s commodity markets.

Achieving and Extending Cost Savings Goals

tarnished in low-price environments.

Knowing when to expect savings and quantifying price impacts in the categories you buy can mean the difference between 5 percent savings and 20 percentplus savings. An “Knowing when to organization that expect savings and pushes for a 10 percent price quantifying price cut rather than impacts… can accepting a 5 mean the difference percent decline will save an extra between 5% savings $50,000 on every and 20%+ savings” $1 million of spend.

Most organizations started the year with cost savings departments, nimbly balancing targets below 5 between maintaining supplier percent, content relationships and their own bottom to allow multiline. As price declines filter through year lows for supply chains, many organizations material prices are struggling to answer the question: to pass by without extracting the full “Are we aiming high enough for cost value. Best in class organizations, savings in 2015?” on the other hand, can lean on In December 2014,The Institute econometric models to trace cost of Supply Management (ISM) in declines through supply chains to the United States achieve optimal asked purchasing timing and cost managers how Models “…purchasing managers savings. much they expect that fail to track are ill-equipped to the movement prices to change in 2015. A startling capture appropriate of cost savings 59 percent of cost savings in today’s through supply respondents chains are

commodity markets.”

The Past is Prologue The aforementioned cuts to commodity prices have already pushed prices lower in many key categories, setting a floor for cost savings at the next negotiation. But for many categories, this is just the beginning; IHS is forecasting significant price cuts still to come for a number of key material and equipment categories.

Each industry and position in the supply chain has reason for hope, due to the broad-based nature of

Special Edition/September 2015 Supply & Demand Chain Executive 11

cost savings toolkit

Figure 1: Peak to Trough Declines through May 2015 in gure 1: Peak to Trough Declines through May 2015 in Key Categories throughout Supply Chains help you to achieve Key Categories throughout Supply Chains

awareness of the impact on your purchases today, and in the future.

real cost savings.

Hot-­‐Rolled Steel Sheet

• Total Direct Materials: -­‐38.5% • Scrap: -­‐41.4% • Coal: -­‐3.6%

Metal Stampings

• Total Direct Materials: -­‐26.6% • Hot-­‐Rolled Steel Sheet: -­‐32.6% • Galvanized Steel Sheet: -­‐26.0%

Steel Pipe

• Total Direct Materials: -­‐19.2% • Steel Plate: -­‐29.1% • Iron and Steel Foundries: -­‐1.6%

Valves

• Total Direct Materials: -­‐3.6% • Iron Foundries: -­‐2.0% • Copper Foundries: -­‐6.1%

Mining Machinery

• Total Direct Materials: -­‐6.6% • Bar Steel: -­‐12.1% • Iron and Steel: -­‐15.0% • Speed Changers: -­‐0.4%

AircraO Engines

• Total Direct Materials: -­‐1.0% • Forging and Stamping: -­‐1.5% • Iron Foundries: -­‐2.0% Source: IHS

the declines. But the timing and magnitude varies based on the key materials in the industry and their location in the supply chain. Figure 1 highlights the breadth and depth of declines and the range of savings opportunities that are already available.

The cost declines have not just impacted commodity prices.

Intermediate goods such as metal stampings (-26.6 percent), steel pipe (-19.2 percent), and industrial valves (-3.6 percent) have already shown steep declines in their direct materials bill and finished goods such as mining machinery (-6.6 percent) and aircraft engines (-1.0 percent) are not far behind.

Raw

17/20158/17/2015

Example 1: Specialist Alloys or Materials To best prepare for purchases of specialist alloys or materials, it is beneficial to understand the composition of the material. With this information, you can benchmark surcharges and costs against the market prices for the individual component materials.

Armed with a forecast of where prices and surcharges are headed in the near future, you can determine the most favorable contract position, whether it be to lock in a contract price, or float on spot. You can also navigate the complex waters of surcharge implements, with full

Example 2: Industrial Valves To prepare for the negotiation of various types of equipment, it is best practice to understand the contributions of material costs to overall production costs. Armed with the knowledge that your supplier costs have declined significantly, you can use fact-based negotiation tactics to achieve cost savings. For industrial valves, it is beneficial to know that over 20 percent of production costs are related to steel and steel-based parts. On average prices for those categories have declined by nearly 10 percent. These models give you the means to estimate the impact of commodity prices on your suppliers’ costs, enabling you to benchmark price concessions and gain leverage in negotiations. Approaching supplier negotiations with full tran sparency can improve collaboration and ensures mutually beneficial results. ■

8/17/20 Share of Production Cost

Industrial Valves

45.7% 4.2% 3.8% 10.2% 3.5% 7.9% 3.4% 0.4% 4.5% 4.5% 3.3%

DIRECT MATERIALS Spot Price Merchant Bar Carbon Steel Spot Price, Structural Shapes Carbon Steel PPI, Iron Foundries PPI, Steel Foundries PPI, Fabricated Metal Products PPI, Bolts Nuts Rivets and Washers PPI, Metal Stampings PPI, Copper and Other Nonferrous Foundries

What does it mean for you?

PPI, Nonferrous Forgings PPI, Rubber and Plastics

The key to leveraging commodity price declines in your negotiations is being able to quantify the impact of material price declines Composi=on: on the equipment you buy. Cost models that measure the contributions of key inputs to your suppliers’ production costs can

Source: IHS

Industrial Valves

Spot Price Merchant B Spot Price, Structural PPI, Iron Foundries

Forecast for US:316 EU:4401

PPI, Steel Foundries

9,000

PPI, Fabricated Metal P

8,000

Si

7,000

($/metric ton)

-3.6 -11.8 -17.0 -1.6 -0.9 -0.8 -0.3 -1.3 -4.1 0.0 -0.8

DIRECT MATERIALS

10,000

PPI, Bolts Nuts Rivets Ni

6,000

PPI, Metal Stampings

5,000

Mo

4,000

Mn

PPI, Copper and Other Fe

3,000 2,000

PPI, Nonferrous Forgin Cr

1,000

0 2004:1

2015 Price Change (Forecast)

2005:1

2006:1

2007:1

2008:1

2009:1

2010:1

2011:1

2012:1

2013:1

2014:1

2015:1

PPI, Rubber and Plasti

2016:1

2017:1

Source: IHS

12 Supply & Demand Chain Executive Special Edition/September 2015

IHS Forecast: Steel Alloy 316/4401

price mechanisms

Common Challenges for Contract Price Mechanisms

By Laura Hodges and John Anton, IHS Operational Excellence and Risk Management

Five price data pitfalls to avoid when linking price data to contracts…and how to avoid them

U

nderstanding the exact meaning of price data before signing contracts to procure goods and services can mean the difference between money saved and money left on the table during the negotiation process. More companies are linking price data to escalate the value of long-term contracts to mitigate risk and as such, are realizing that identifying reliable and timely price data is a key aspect of mitigating risk (particularly for unforeseen risk) while achieving and maintaining market prices.

Unfortunately, many contracts that companies are using today are not set up properly. This fact alone prevents buyers from fully capturing the significant drops in commodity prices that IHS has tracked since mid-2014. Ignoring this aspect of the procurement process also exposes companies to undue risk and finds companies potentially wasting and foregoing millions of dollars.

If you feel confident that you’ve received a fair price when negotiating a buy, then linking the contract to a price adjustment index over the course of that long-term agreement

(or even to a set of price indices), is a simple and effective way to maintain a market price for your purchases.

Price Volatility is Here to Stay

falling material prices.

There are five stumbling blocks that companies tend to run into when negotiating contracts right now. Each of these increases the risk to your company and could translate into millions of dollars of either lost revenues or increased costs.

Price volatility isn’t going away anytime soon, hence the need to pay close attention to the linkage between contracts Price volatility is not going away Figure 1: Price Volatility and price Industrial materials prices mechanisms.

According to the IHS Material Price Index, the pricing for a core basket of tracked materials has fluctuated significantly in recent months.

These price fluctuations resonate across the global supply Not Taking the Time to chain, where linking contracts to Understand the Price Data price data stands as one of the most The first pitfall occurs when common ways to effectively capture buyers lack clear knowledge on falling prices right now. In fact, a what the price data are measuring. recent IHS survey found that 55 Many times there is just not enough percent of firms link contracts to price documentation to understand what mechanisms as a means of capturing the data include, nor is there enough Source: IHS

© 2015 IHS

© 2015 IHS

1

Common Pitfalls for Contract Price Mechanisms ■■ ■■ ■■ ■■ ■■

You do not fully know what the data are measuring You do not understand when the data are updated or revised You do not track the data You do not start the base period value from the right time You do not build an appropriate collar or trigger

Special Edition/September 2015 Supply & Demand Chain Executive 13

price mechanisms information on the advantages or disadvantages of the current setup (in some cases due to the exit of an employee who set up the original arrangement). This is a critical issue that can be solved with a simple step: if you get a contract, research the data.

Within the steel sector, for example, spot prices move quite a bit differently than contract prices.

This tends to create issues for buyers, many of whom turn to the Producer Price Index to negotiate cold-rolled sheet steel buys when in fact they should turn their attention to carbonsteel specific spot market prices. So while the PPI includes cold-rolled steel (both stainless and electrical), those products move in different directions and at different times.

Using a carbon-steel specific spot price is a better choice. The key is to examine the index carefully and make sure it actually measures the product you are buying. At a minimum, it should move in the same direction at the same time, and follow approximately the same magnitude as that commodity.

Ignoring the Indexes The second obstacle surfaces when buyers do not understand the data update or revision schedule. This scenario can translate into financial loss for your company on both sides of the coin. Most contracts with adjustment clauses are symmetric in nature, so your price rises if the index rises and you get a price cut if the index falls. Sellers are generally very good about billing buyers for any increase to which they are entitled, but they are not always as fast to dole out price cuts, even when warranted.

So while the reductions should happen automatically, you may have to ask for them. Additionally you need to know when the data is updated and revised, and be specific

Example of an appropriate collar or trigger

on when you will recognize the price adjustments in the contract.

Not Starting from the Right Point

Cold-rolled sheet price, $/metric ton 1,400 A good trigger to use would be + / - 4% on a quarterly basis

1,300 1,200 1,100 1,000 900 800 700

The trigger would have been reached 4 times over the past 3 years

600 500 400

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

The third pitfall finds buyers starting the base period values from an inaccurate point. This is happening a lot right now: buyers are using annual or quarterly averages instead of current values. With prices fluctuating significantly, it pays to use the most current, relevant data possible. To maintain and achieve market pricing over the course of your contract, you have to start at the right time.

If you are setting the price for the next year, be sure to start from the correct point. Realize that many prices fell during the 2013-14 period, so if you’re setting your 2016 prices today you’ll want to look at today’s pricing levels, not the average of 2013 or 2014. When prices are rebounding, you will see regular increases. If you add those increases onto the 2014 average, rather than today’s depressed level, you will see 2016 higher than it should be.

2

© 2015 IHS

falling, you need to be aware of this movement to capture those declines.

Not Using Collars and Price Triggers Finally, buyers also run into challenges when they don’t build appropriate collars and/or price triggers into their contracts. A price collar is used when you only want to adjust price by significant moves (up or down) in prices. By picking the wrong collar, you could miss out on substantial price declines or spend too much time managing the contract. To select the most appropriate collar, be sure to look at the price variation within the data itself. A calculation of a standard deviation of the quarterly or monthly data would provide an excellent understanding of its past variation and prove useful to pick the collar or price trigger for your contract.

Letting Tracking Fall by the Wayside

For Best Results, Do Your Research

The next pitfall involves the tracking of the data itself —or, rather, a lack of those tracking activities.

Even if you have the price mechanism set up, you’re not always compelled to track the data—a move that you should be making to understand whether prices are falling, rising, or moving sideways. In today’s commodity environment, this step is particularly important; if prices are

By taking the time to understand the price data before signing contracts to procure goods and services, documenting the reasons for your selections, specifying contracts accordingly, and considering all price data advantages and disadvantages, buyers can effectively position their companies for success in today’s volatile price environment. ■

14 Supply & Demand Chain Executive Special Edition/September 2015

case study the energy supply chain

Case Study:

Energy Supply Chain Transformation

T

he procurement job function is in transition.

Over the last 20 years, we’ve seen procurement elevated from a transactional role to a strategic value contributor. With that change in role, the pressures on procurement to continuously improve, lower costs, and drive competitive advantage have grown dramatically. Under this new pressure, procurement teams are adapting a more strategic framework for managing supplier relationships.

Best in class procurement teams are tracking supplier input costs to achieve cost savings. As companies strive to quantify supplier input costs, IHS market insights are there to support their needs.

Energy companies have faced particularly challenging conditions in the last few years. There have been tumultuous conditions both on the oil price side—where prices have been extremely volatile—and on the production side, where unconventional drilling and a number of new production methods are transforming supply chains for some energy companies. These forces are coming together to create an interesting set of challenges for energy companies that for years enjoyed an era of high crude oil prices and relatively low operating costs.

In assessing the impact of price swings, unconventional drilling practices, and other developments on the energy industry, it’s clear that

even during years marked by revenue expansion, owners and operators have experienced margin contraction.

This is taking place because as costs continue to grow, they’re doing so in a way that outpaces revenue growth. Since the fourth quarter of 2004, upstream capital costs have risen by 115 percent, but industrial commodity prices during that time have only risen by less than 10 percent. This is partly reflective of rising energy demand and regulatory impositions, but also, and more importantly, loose cost control practices.

A major oil and gas field service company recently underwent a major supply chain transformation in an effort to mitigate the risk imposed by these market conditions. Supply

chain leaders within the organization recognized that past performance had not driven the sort of cost savings the company needed to achieve in order to remain competitive.

The procurement objective was to achieve better cost performance by transitioning the team from a “three bids and a buy” culture, to one reliant on informed category managers that set global strategies for the buyers and project teams.

There were four main ingredients in this transformation—talent upgrade, more contemporary sourcing process, better tools, and a rigorous program to analyze and anticipate supply markets. IHS was the most prominent, durable pillar in their supply market capability.

Their analysts use the IHS Pricing

Special Edition/September 2015 Supply & Demand Chain Executive 15

case study the energy supply chain PROCUREMENT PEER REVIEW:

Benchmarking Your Procurement Practices Concessions should be dominating your supplier negotiations given the recent unwinding in commodity prices. However, many supply chain leaders lack confidence in their teams’ ability to capture those cost savings. Buyers need to be closely evaluating their suppliers’ cost structures to achieve significant cost savings.

In a recent study co-authored by IHS and Supply Chain Management Review, more than 240 leading supply chain executives provided insights on the efficacy of their procurement and sourcing operations. We’ve leveraged this research, alongside regular polling of our client base to provide a brief review of challenges and best practices in Procurement Excellence.

Best in Class companies are more likely to centralize their procurement Best in Class operations as well as allocate the necessary funding and resources allowing for companies are four greater procurement efficiencies. Best in Class companies are four times more likely to have a Procurement Excellence program in place. times more likely to Further, they place greater importance on key performance indicators such have a Procurement as cycle times, warehouse costs, and environmental or green initiatives.

Excellence program Effectively leveraging a highly proficient procurement function within their operational excellence platform, companies are realizing: in place.

■■ cost savings ■■ better decision-making and negotiating through the use of current and more accurate data ■■ upgraded workforce optimization; and ■■ improved planning and execution of risk mitigation.

In practicing key operational and performance methodologies such as Procurement and Operational Excellence programs, organizations are well-equipped to address and, subsequently, hit performance goals.

So, how does one elevate performance? We asked our client base how they will capitalize on falling material costs, and the overwhelming response was by improving access to market intelligence and cost insights.

& Purchasing forecasts, along with models for key procurement areas, industry insights, to understand and valuable written analysis to this supply market trends and likely client. However, the most important inflection points. These services part of IHS’ support of this business became so ingrained in their habits, transformation comes through its that they wrote IHS into sourcing analysts. IHS analysts became a procedures.

Their category “Our successful supply chain transformation and project was directly linked to better supply teams were able to access regular market data and external analysis. Our IHS consistent subscription allowed us to shape supply forecasts for strategies and negotiations with confidence thousands of spend and insight...which led to value creation.” line items through the IHS portal. The category functioning extension of the company managers became supply base procurement team, offering training, experts through partnership with advice, and support for critical IHS. IHS still provides regularly business decisions. updated historic and forecasts data The company’s supply chain for key costs and prices, detailed cost transformation was driven by 16 Supply & Demand Chain Executive Special Edition/September 2015

this partnership. Regarding the engagement, the head of purchasing stated: “Our successful supply chain transformation was directly linked to better supply market data and external analysis. Our IHS subscription allowed us to shape supply strategies and negotiations with confidence and insight...which led to value creation.” Their IHS subscription allowed them to shape supply strategies and negotiations with confidence and insight, which delivered tremendous value in savings, supply continuity, and customer credibility. While improvement remains continuous, the supply chain team met its objective of elevating procurement practices from a “three bids and a buy” culture, to one of strategic support and value add for the business. ■

manufacturing cambodia

Is Cambodia

THE NEXT BIG CONTESTANT in low-cost manufacturing?

By Jola Pasku, IHS Global Economist

Cambodia’s economy has come a long way from the utter devastation of the civil war era: the country is now the world’s 10th largest garment producer as cheap labor and foreign direct investment-friendly policies facilitated the development of a vibrant garment manufacturing sector. Cambodia’s manufacturing success is not exclusively the result of domestic structural changes, it reflects broader changes in Asia’s manufacturing landscape and the ever intensifying search for low-cost manufacturing opportunities. This report examines the rise in the Cambodian manufacturing, the underlying factors behind its improving competitiveness, and the challenges ahead.

C

ambodia’s economy dependence on external demand. has transformed in a Restored political stability remarkable fashion over following two decades of civil war the past two decades. and a reorientation towards a market Economic growth has economy helped launch the garment been rapid, although quite volatile, industry in the mid-1990s. Cambodia since the early 1990s, as the country benefitted from quota-free access transitioned from a central-planning to the United States, while many system to an open-market economy. traditional regional manufacturing Occasional political uncertainty and bases, such as China, were quota major external shocks, such as the constrained at the time. Additionally, Asian financial crisis in 1997 and the having gained preferential access to global economic recession in 2008, the European Union in 1997, further have driven the volatility in economic facilitated access to key markets and growth, but Cambodia’s economy well positioned Cambodia as an weathered crises well and recovered quickly. Real GDP Growth in Cambodia 14 1,200 growth has exceeded 5 percent 12 in most years—reaching double 1,000 10 digits from 2004 to 2007—then 800 8 dropped drastically to zero in 600 6 the wake of the global recession 400 4 in 2009 before recovering 200 2 quickly to 6 percent in 2010.

0 0 Trade became a major 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 impetus for growth for the small GDP per capita (left scale, current USD) Real GDP (right scale, % change from a year earlier) domestic economy, as a result of policy-makers’ savvy reforms Total merchandise exports in Cambodia aimed at gaining access to far 10,000 70 9,000 larger markets. In 1993, total 60 8,000 merchandise exports were $284 50 7,000 6,000 40 million (U.S.) and accounted 5,000 30 for only 11 percent of GDP. By 4,000 3,000 20 2013, exports jumped to $9.3 2,000 10 billion (U.S.) and almost 61 1,000 0 0 percent of GDP, reflecting the 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 significance of trade in overall Merchandise exports (left scale, current USD) Merchandise exports (right scale, % of GDP) growth, but also an increased Source: IHS

© 2015 IHS

Source: IHS

© 2015 IHS

Special Edition/ September 2015 Supply & Demand Chain Executive 17

manufacturing cambodia Per capital income in selected Asian countries (current USD) COUNTRY

1993

2000

2007

2013

Bangladesh

289

356

544

958

Cambodia

251

299

628

1007

Lao

287

321

702

1661

Myanmar

150

145

317

931

Nepal

187

237

398

694

Sri Lanka

586

855

1614

3280

Thailand

2153

1969

3738

5779

Vietnam

189

433

919

1911

attractable hot spot to many garment investors.

Throughout this period of robust economic expansion, the country’s per capita income more than doubled in amount, but Cambodia remains one of the poorest countries in the world, with per capita income just reaching the $1,000 (U.S.) mark—a level comparable with Bangladesh and Myanmar. The country’s economic base is extremely narrow, with rice dominating the rural economy, and garments the manufacturing industry.

Composition of Cambodia’s manufacturing sector Manufacturing exports dominate as

the major commodity group exported since 2000, with their share in total merchandise exports averaging over 90 percent. Agricultural exports are the second biggest commodity exported averaging 4 percent, and fuels and mining products are the smallest group, accounting for less than 1 percent throughout the period.

Production is highly concentrated in a low-value-added sub-sector, as garment exports represent the largest commodity exported within manufacturing. The dominance of garment exports, which averaged more than 60 percent of total exports throughout the past decade, has made the economy particularly vulnerable

to sector-specific price and demand shocks.

At present, Cambodia’s garment sector operates on the final phase of garment production, which encompasses cutting and making yarns and fabrics into finished garment products and where value added and profit margins are relatively low, which supports growth to an extent, but also represents a limiting source in the potential growth going forward. In producing these finished products Cambodia relies almost exclusively on imported materials, given the lack of a domestic textile industry.

Drivers of Cambodia’s competitiveness, comparison with other rivals in region A number of factors, within and beyond Cambodia’s borders, are responsible for fueling the country’s burgeoning competitiveness as a regional manufacturing hub. Rising wages in China and Southeast Asia undercut the competitiveness of the major traditional manufacturing centers and allowed emerging markets, such as Cambodia, to

Timeline of Cambodia’s Major Trade Milestones 1996

» Gained most favored nation (MFN) status from the US.

1997

» Gained Generalized System of Preferences (GSP) status from the EU.

1999

» Became an ASEAN member. » EU-Cambodia Textile Trade Agreement granted duty and quota free access to the EU for Cambodia’s garments.

2004

» Joined WTO and gained MFN/GSP status from all WTO member countries. » Termination of the Multi-fibre Arrangement (MFA) regime. No more quotas on global garment trade in general.

2009 2011

» ASEAN-Japan Comprehensive Economic Partnership came into effect. Cambodia enjoyed duty-free export treatment even when using imported fabrics from ASEAN or Japan. » EU relaxed its rule of origin and gave Cambodia duty-free export treatment even when using imported fabrics.

18 Supply & Demand Chain Executive Special Edition/September 2015

manufacturing cambodia

gain market share in price-sensitive segments of the industry. As a result, many multinational companies have responded to the changing regional trends by shifting their investments from their principal offshore manufacturing platforms to frontier economies such as Cambodia.

Low wages, a favorable geographical location, and a benign demographic profile helped grow Cambodia’s manufacturing base. Cambodia’s workers have one of the lowest mandated minimum wages in the region, which helped lure manufacturing companies looking to locate or relocate their businesses.

Adidas, GAP, and H&M are only a few of the many major global clothing brands that have moved production to Cambodia in recent years.

Two rounds of large minimumwage increases in neighboring Thailand in 2012 and 2013 increased labor costs substantially there, which had a positive impact on Cambodia’s relative competitiveness as a production center. In 2014, the Bangkok Post reported that TK Garment, a leading original equipment manufacturer for Thai

tax incentives it offers to garment investors. Except for land ownership, Cambodia treats domestic and foreign investors equally, and 100 percent foreign-owned firms are also allowed.

Some of the incentives include a 100 percent exemption from export tax, 100 percent import duty exemption on construction materials, production equipment, intermediate goods, and raw materials for export-oriented goods.

Outlook and implications

Cambodia’s garment industry is an export-oriented industry in which most of the garment production is destined for export. Although Cambodia has secured a strong global presence in the manufacturing industry, its exports remain narrowly based and only concentrated in a few markets—the U.S. and the EU. The dependence on a few major markets has left the economy vulnerable to changes in external shocks, which was experienced in the wake of the global financial crisis in 2008 when Cambodia’s growth dropped to zero percent and the export demand plunged. The demand recovered quickly from the United States and Except for land ownership, Cambodia the European Union, treats domestic and foreign investors but this experience is a strong reminder equally, and 100 percent foreignof the importance owned firms are also allowed. of economic diversification and fashion lines, relocated its largest development of a broader range of production site to Cambodia to avoid export destinations. higher wage costs.

Given the lack of domestic textile Another important factor driving industry, which would allow for Cambodia’s garment industry more integrated production processes edge lies in the government’s FDIand an increase in the domestic friendly policy and the number of value added, the focus in low-wage,

low technology production could compromise Cambodia’s export competitiveness, if the country fails to upgrade its industrial base. The high concentration of production in the garment industry represents a constrain in achieving higher economic growth, and diversification towards higher value and more

The high concentration of production in the garment industry represents a constrain in achieving higher economic growth… technologically advanced products away from labor-intensive industries remains a crucial challenge for sustained growth in the medium and long term.

On a positive note, an increasing number of Thailand-based Japanese companies are now looking to take advantage of lower production costs and expand their activities to Cambodia in auto parts and electronics, which could prove to be beneficial for the diversification of the manufacturing base beyond garments.

For example, Japanese auto-parts makers Yazaki and Sumitomo Wiring Systems have recently announced their decision to shift some of their production sites from Thailand to Cambodia.

In order to accelerate diversification and improve competitiveness in a changing global trade environment continued improvements in human capital, including through education and training, infrastructure, and the business climate are needed. ■

Special Edition/ September 2015 Supply & Demand Chain Executive 19

Supply Chain Risk

Strategic and Operational Risks in the Auto Industry

By David Hunt

It is also important to evaluate the predictive indicators of a full spectrum of risks—including geopolitical and economic. Some are at country-level but for others it is possible to ascertain risk at specific locations—which is important when evaluating the risk of disruption to Material Cost Index tracks a basket supplier prospects due to protests basic need for global of over 25 input materials for vehicle and riots, terrorism, or violent sourcing teams is to manufacturing and weights the organized crime, which can be highly identify availability of individual material costs based on differentiated within a single city. new suppliers for specific the composition of a representative Here, the specific locations of all components. Once that vehicle. The index can be used to individual tier 1 auto suppliers in the identification of potential suppliers show costs over time, and also to three countries were accessed from is done, the question follows: how compare across countries. the IHS Automotive Component competitive can different countries Another variable is manufacturing Analytics database, risk scored, and be in supplying components? Matteo wages—in 2015 Mexico’s are 12 aggregated to the country level to give Fini, a supplier analytics expert at percent of those of the US, in the overall location risk.

IHS Automotive suggests a good Argentina 47 percent and for Brazil Compared with the U.S., all three starting point for any strategic review 21 percent. Emily Crowley, an IHS countries have significantly higher of global operations or supplier base economist, points out though that overall risk, but in different ways. is the establishment of rigorous in Mexico and Brazil, it would In Argentina, for example labor metrics that allow the comparison take approximately four workers to strikes and tax increase are of most and benchmarking of risks versus produce the same amount of output concern, whereas in Mexico, terrorism costs. One approach is to evaluate as one U.S. worker, and in Argentina (included in our definition of violent component pricing alongside country it would take three workers. By organiezd crime) and corruption transportation costs, differentiating adjusting wages for productivity, and are key factors. In Brazil, protests & between transportation modes. then taking a weighted average of riots and labor strikes were top risks.

Where such detailed component these unit labour costs and the raw Appreciation of these differences can price data is unavailable, an approach material costs, we can see the lowest help feed into strategic planning at to measuring component costs is cost option in our sample is by some an early stage—for example if violent to evaluate manufacturing wages margin Mexico (cost score of 0.58 organized crime is going to be a alongside materials inputs costs, relative to U.S. at 1)—factoring in key threat, then corporate security and benchmark these relative to the forecasts for these variables would needs to be part of the process early United States. The IHS Auto Raw further improve long term planning. on. If labor strikes are going to be an endemic issue Table 1 - Component Supplier Counts (Source: IHS) then prioritising relationship ElectricalSupplier Country Chassis Exterior Interior Powertrain Thermal Electronics building with 2 9 3 3 Argentina government and unions may be 7 4 18 4 12 Brazil critical.

2 14 10 30 10 21 Mexico

A case study focused on Brazil, Argentina and Mexico evaluating some of the integrated data and analytics tools that teams involved in the selection and management of global supply chains can utilise to address some of their key challenges.

A

20 Supply & Demand Chain Executive Special Edition/September 2015

Supply Chain Risk Figure 1 - Risk Score Detail Table (Source: IHS) COUNTRY DISRUPTION

COUNTRY ECON

COUNTRY POLITICAL

LOCATION RISK

Country

Infrastructure Disruption

Labour Strikes

Recession

Capital Transfer

Contract Enforcement

Corruption

Tax Increasew

Protests & Riots

Terrorism

Argentina

1.60

4.80

4.10

4.00

3.40

3.50

4.40

3.92

2.03

Brazil

2.50

3.30

2.30

0.90

1.90

2.70

2.40

3.32

1.69

Mexico

1.00

3.70

1.10

0.30

1.70

4.20

2.30

2.62

4.61

United States

0.60

1.20

0.40

0.10

0.40

1.20

1.30

1.70

2.00

RISK SCORE

Combining cost and risk scores strong lobbying from the sector components. There is risk of fresh into a single index reveals Mexico allocation of dollars for the auto protests in the one–year outlook, as has the best risk-adjusted sourcing industry went up by 23 percent. This the main causes of the unrest persist. score, with Brazil close to the U.S. makes the operational environment The tariffs charged by truckers, benchmark but Argentina, due for carmakers very unpredictable, which have fallen by more than 25 to relatively high costs and very with significant risk of disruption to percent, are unlikely to recover soon. significant risks is ranked bottom. production lines if capital flight forces Meanwhile, the government, which is Such metrics while useful for the government to tighten controls on struggling with an unsustainable fiscal benchmarking mask nuances in hard currency. Import and currency deficit of more than 7 percent of the risk profiles of each country. controls will continue to be managed GDP, is severely constrained to offer Carlos Caicedo, an IHS Country on a selective basis through 2016. the fuel subsidies that in the recent Risk analyst, highlights Argentina’s The key dynamic driving risk in past managed to defuse conflict with currency controls, which impair Brazil is increasing unrest by truckers the powerful truckers association.

OEM’s ability to source parts and over increases in fuel and toll road Such risks highlight the importance foreign produced inputs. The tariffs. This and growing difficulties for sourcing teams to understand the depletion of foreign reserves and the of heavy truck owners to serve debt extent to which their supply chain state interventionist policies of the contracted with banks triggered in is exposed to disruption on each current government have resulted in February two weeks of road blockades transportation node, and to be aware the introduction of stringent capital that extended to 12 states. The of the risks associated with specific and import controls, which have blockades caused severe disruptions suppliers. Combining data from IHS caused disruption to production lines of the country’s largest ports, Automotive and IHS Country Risk in most car assembly plants over the particularly Santos, which handles allows such granular mapping of the last two years. Allocation of dollars most manufactured goods entering or geographical footprint of suppliers, for the auto sector is done by the leaving the country, and consequently their risk and – moving from the MinistryCountry of Industry quarterly and is on road transport—this had a direct strategic to the tactical/operational (Cost Scores) Cost Score Risk Score Sourcing Score reviewedArgentina regularly. This means that1.339 it impact manufacturing, with levels - daily intelligence on events 3.498 on autos 1.68 Brazil 0.851 2.410 0.75 could go up or down depending on production lines disrupted to lack of that may cause disruption. In Mexico, Mexico 0.577 2.298 0.48 levels of foreign where are suppliers United States Figure 1 - Summary Sourcing 1.000 1.000 Scores (Source: 1.00 IHS) reserves. Dollars most exposed to 4.000 for the sector violent organised crime Argen0na were cut sharply and cargo theft from 3.500 1.68 in the second cartel hotspots such as 3.000 half of 2014 Coahuila, which in 2015 2.500 in the wake accounted for 75 percent Brazil 2.000 Mexico of Argentina’s of the country’s 32 0.75 0.48 1.500 technical million supplied airbag United States default. units?

1.000 0.0 However, Alastair Hayfield, 0.500 in early July from IHS Automotive, 0.000 2015 and after explains that operational 0.000 0.200 0.400 0.600 0.800 1.000 1.200 1.400 1.600 COST SCORE

Special Edition/September 2015 Supply & Demand Chain Executive 21

Supply Chain Risk Political violence risk Lowest

Highest

Component volume (2015)

Coahuila

Smallest

Largest

Component Door Trim Panel Seat Assembly Seat Recliner Exhaust Cold End Exhaust Manifold Engine Cooling HVAC - Module

dashboards blending intelligence on disruptive events, with detailed supply chain data, can assist in maintaining business continuity. For example, in July 2014, in Rosario, Argentina, social and political activists blocked the RosarioSuch analytics point to another Buenos Aires highway to protest key question—which suppliers are against dismissals from an automotive we overexposed to as an OEM, what OEM. Does this matter? A dashboard proportion of our production is shows only one component supplier reliant on a supplier? How important potentially affected in Rosario itself, a customer are we—what proportion with yearly production of 233,000 of a supplier’s revenue do we account seat assemblies and 7,000 seat for compared with our competitors? recliners. GM’s Rosario production While this case study has focused plant accounts for 97 percent of this on assessing geopolitical and security production, with Honda’s Campana disruption, for which location plant taking 3 percent. However, the is crucial, there are several other highway is also on the route between factors to be incorporated in any Buenos Aires and Cordoba—so if model—for example, short term the event continued to disrupt cargo financial indicators of suppliers. A then potentially shipments from the more complete solution would also seven suppliers in that city may be 1 day's Component Volume at Risk Distinct count of Vehicle evaluate how competitive a supplier disrupted? Factoring in an estimated 2,294 11 2,087 11 panel is on quality, delivery and costs, one day of disruption allows us to see 20 4 and integrate both third party and the total component volumes at risk13 745 830 Industry exposure18 internal data in a coherent system due to the event.

497 8 that connects the dots between may be far wider, with 17 OEM 715 16 strategic planning and operational production plants across Argentina, management. ■ Brazil, Mexico and Venezuela exposed to those suppliers.

1 dday's ay's CComponent omponent VVolume olume aat t RRisk isk 1 2,500

Figure 4 - Industry Event Exposure to suppliers in Rosario & Cordoba by 1 day of component volume

2,000

(Source: IHS)

1,500

1,000

500

Smart manufacturing driving an integrated supply chain Smart manufacturing is the integration of automation technology with IT – and promises to have as large an impact on industry as the adoption of computerized control systems.

Common discussion of smart manufacturing has focused on big ticket items which do novel things: 3D printers which can create intricate designs, self-organizing manufacturing cells or robots that can do the job of many people. But smart manufacturing can deliver on more day-to-day applications as well.

Discrete automation (the assembly of piece parts into complex objects) have the most complicated supply chains of all. The average vehicle will have thousands of parts – and while supply chains are already lean in this industry – automakers will increasingly offer more and more options to customize a vehicle.

This creates enormous challenges for everyone in the automotive value chain. However, by linking customer orders to ERP/ MES systems, then in turn to the manufacturing cells themselves, the supply chain can manage with minimal human supervision.

We are just beginning to scratch the surface in terms of what smart manufacturing can do. Although smart manufacturing has some concrete applications behind it, ultimately it’s just a set of building blocks – engineers are incredibly creative and adaptable and will surely create new ways of working that we have not even conceived of yet.

Can yyou ou iinclude nclude VVehicle ehicle CCount ount iin n ssome ome w way ay oon n tthis his iif f ppossible ossible pplease? lease? EE.g. .g. LLabel abel eeach ach bbar ar w with ith ttha ha Can

0 Door Trim Panel

Seat Assembly Interior

Seat Recliner

Exhaust Cold End Exhaust Manifold Powertrain

22 Supply & Demand Chain Executive Special Edition/September 2015

Engine Cooling

HVAC -­‐ Module

Thermal

For more information on this research and IHS Supply Chain Risk solutions, contact the author: David.Hunt@ihs.com

All the cost analysis you need.

All in one place.

IHS ConnectŽ enables you to price forecasts across the supply chain and – Understand costs Negotiate better Gain the advantage Integrating energy and chemical industry analysis, risk and economic forecasts, plusw now price and cost insights through an intuitive world-class platform, IHS Connect will transform your analysis and enable smarter decisions.

Schedule your demo today to discover more: 9600-PB-0715

IHS.com/procure_Connect

Best-in-class procurement teams are more successfully leveraging reliable data to gain a better understanding of market conditions, prepare for negotiating with suppliers, foster more insightful decision-making and develop cost estimates.

HERE’S THE RESULTS

KEY FINDINGS

82%

KEY PERFORMANCE INDICATORS

82% of the best-in-class organizations have Operational Excellence initiatives tied to sourcing and procurement.

4x

Best in Class companies are 4x more likely to have a Procurement Excellence program in place

2x

Laggards were 2x more likely to report having poor insight as a barrier to meeting business goals

77% 53% 43% Total cost savings

On time delivery

“The ROI we get on IHS’ Procurement Excellence service is one of the best things we spend money on.”

SUPPLY CHAIN MANAGER

IHS.com/pricingandpurchasing

9601-PB-0715

Quality