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As e-commerce changes the underlying economics of business, is the old business model — based on scale — under serious threat?

In my consulting work, some of the packaging companies that I like to track are AEP Industries; Avery Dennison; Ball; Bemis; Crown, Cork & Seal; Owens-Illinois and Sealed Air. These companies supply a wide variety of packaging materials, and looking at them I can get a fairly good indication of the overall industry trends.

However, by looking at their performance in the past 52 weeks, I am disappointed. Other than AEP Industries and Bemis, the rest have not been profitable investments.

Market share as a driver
What concerns me is that when the economy is so good, the packaging sector continues to perform rather disappointingly. What would happen if the economy slows down? My discussions indicate that only the top management in the packaging industry is concerned about the performance of the stock; the middle-level management is still driven by market share.

I am surprised to see that companies continue to add infrastructure to produce more and eventually gain market share. I am a firm believer of profitability over market share, but most middle-level executives do not seem to believe in that because nine times out of 10 their compensation is determined by sales and not earnings, and rarely the stock price.

I am starting to believe that the old business model based on scale is under serious threat. E-commerce is changing the underlying economics of business. In the past, large infrastructure resulted in high market share, which eventually meant excellent cash flow and future growth. This is no longer the case. Vertical integration (as traditionally understood) is starting to become a meaningless business model because it is now possible to outsource practically everything that someone else can do “better, cheaper or faster.”

Traditionally, companies relied on leveraging their infrastructure to bring down the cost of manufacturing to either drive down the overall market price or to increase their margins. Now this is no longer the prerogative of companies with the biggest infrastructure. A small organization can put together a virtual team of providers where each focuses on what it does best — be it manufacturing, technology, product development or marketing. This is a serious threat to a typical company that tries to do everything, since margins on its core competence can be eroded by inefficiencies in everything else that it does.

Is manufacturing no longer attractive?
As I said in one of my previous columns, if you are not the absolute best at manufacturing a product, stop manufacturing it and focus on what you do best. On the other hand, if you are the best, focus on maintaining that position. Somebody in the future will definitely figure out a way to beat you, and you should be prepared to react immediately.

What about those companies that already have a large base of assets? My recommendation is this: retain what you do best and get rid of the rest. I know this is a rather radical recommendation, but the alternative is even worse. I make this recommendation based on my past experiences.

I lived in Japan from 1992 to 1997. During this period, I saw a revolution taking place there. The bubble had essentially burst, and signs of recession were setting in. During the bubble economy, the wages had reached such high levels that the cost of manufacturing went through the roof. However, during the recession when demand dropped, such high cost of manufacturing made the Japanese uncompetitive in the market.

The Japanese companies reacted fast and started cutting down their Japanese manufacturing base. They established plants in several parts of the world and kept only the value-added operations in Japan. Japanese companies realized that they should focus on what they do best, that is, product design and marketing. Manufacturing could be accomplished by building skill set and infrastructure overseas.

As a final thought, do what General Electric does. Every couple of years, it reinvents itself. The company looks hard at what it needs to do to thrive till the next opportunity to reinvent arises.

The hard reality of business is that while you may invest enormous resources in developing internal capabilities and strengths, sometimes the environment changes faster than you can anticipate. This is exactly what is happening now. Don’t try to beat the marketplace. Instead, adapt your business model to the marketplace.

Labels: manufacturing, packaging industry, production management

posted by eCreativa Media  # 2:12 PM 0 Comments

The old model of integrated manufacturing, generally seen as inflexible, is now facing many questions. With today’s modern communication technologies, companies can now increase system flexibility by creating a supply chain involving multiple vendors rather than trying to do everything themselves. What will this mean to the packaging supplier?

One of the barriers to innovation and adoption of new technology in the packaging industry that I constantly hear about is the reluctance to change equipment. We all understand how costly it can be to change packaging equipment every few years. For instance, in many cases advantages of flexible packaging over rigid packaging are clearly visible, but a financial analysis generally indicates delaying such a changeover until the assets have depreciated.

Thus, generally only new plants take advantage of state-of-the-art technology while old plants are stuck with inefficient equipment and processes until the plant is ready for the next round of renovation.

Questioning the old model
The end-users of packaging materials, generally for reasons beyond their control, have traditionally been expected to install their own packaging lines. Making heavy investment in plant and equipment can in many cases retard the progress of technology in the industry.

Interestingly, there are instances when a packaging supplier will bear the total cost of new equipment or heavily subsidize it when it is no longer in a position to support it. Generally, this is a privilege usually granted only to large customers. Small customers are still pretty much on their own and have to shell out significant sums of money to keep up with technology.

This old model of integrated manufacturing has recently been questioned because of the availability of possible alternatives. A major downside of integrated manufacturing is that it breeds inflexibility. A soup manufacturer that is also integrated into manufacturing of packaging materials cannot respond to changing customer tastes as fast as a competitor that procures packaging materials on an as-needed basis and can easily switch suppliers or product depending on market movements.

Supply chain focus
Integrated manufacturing has traditionally been justified on grounds of lower cost and higher profit margins. This, in fact, is the case when the number of suppliers competing for your business is limited and coordination of suppliers can be a nightmare. Currently available communication technology, however, makes it possible to manage the supply chain more efficiently and cost effectively.

Thus, the two key questions that end-users should be asking now are:

• Is owning packaging equipment hindering access to new technology?
• It is possible to increase system flexibility by creating a supply chain involving multiple vendors rather than trying to do it ourselves?

Some of the large companies are already treating their packaging needs as a component of the overall supply chain management. Transferring most of the responsibilities to the packaging supplier, these companies can then focus on what they do best, that is, their own product line.

What’s it mean to packaging suppliers?
Two major advantages that packaging companies will realize as a result of their customers implementing the latest supply chain management systems are economy of scale and higher system efficiencies. By being responsible for actually supplying a packaging solution rather than material or equipment, the overriding considerations would be higher system efficiency, speed and state-of-the-art manufacturing, rather than a customer’s willingness to upgrade to a higher level of technology.

Secondly, packaging companies can more efficiently manage their production schedules and inventory levels because these would be driven by demand from a pool of customers they serve and by how efficiently they can meet the demand based on maximizing their internal resources.

This implies that supply chain management will also become a major consideration for packaging companies. They will have to integrate their information systems with their customers and suppliers in order to meet their obligations in the most cost-effective manner. Some converters will find it difficult to implement these systems because this can mean significant upfront capital investments.

I am hoping that emergence of such systems on a wider scale will benefit both the packaging suppliers, their customers and other myriad industry players who are part of this group. By letting each company focus on its core business and getting better at managing alliances and partnerships, higher profits should result for everyone.

A focus on maximizing supply chain efficiencies will not only result in strong competitive advantages to the leaders, it can also mean higher rates of innovation in the entire packaging industry.

Labels: cost cutting, efficiency, packaging industry, production management, supply chain, value chain

posted by eCreativa Media  # 1:42 PM 0 Comments