On Bourbon, Oil Price, and Innovation

Image by Yarek Waszul

An interesting article in today’s Times about two “liquid” industries, oil and bourbon. The two industries, unlike as they are, have one thing in common: long lead times from the initial investment to finished production. Good bourbon takes more than 10 years to age, and so does the oil exploration and production. The article argues that the bourbon is in the same state as the oil was 10 years ago: demand exceeding supply and prices are rising. In the oil industry rising prices prompted more than double investment in exploration, and now that the supply has grown, prices have dropped. Bourbon is taking a different approach:

“We’ve been adamant about not raising our prices to our distributors much beyond the cost of goods and inflation,” Mr. Brown said. “The reason for that is very simple. We’re in this business for the long term. Just because bourbon is hot right now doesn’t change our way of thinking to say let’s take advantage of the situation.”

Buffalo Trace and other bourbon makers try to carefully allocate their product to distributors around the country at what is, effectively, slightly below the market-clearing price. A result is headlines like “The Great Whiskey Shortage of 2013.” On the gray market, bottles of 23-year-old Pappy Van Winkle reach four-figure prices.

But the bet the bourbon industry is making is that there is more money to be made in the long run by cultivating a new generation of bourbon drinkers among young adults, and by building loyalty among customers in all corners of the United States, and eventually the world.

Clearly, the bourbon guys are concerned about keeping competitors off the market. Had the oil industry followed the same path, I suppose, the todays’ world would have been quite different. Many innovations have been sparked by the high oil prices: Teslas, Leafs, Solar Cities of the world. The “boom bust” cycle, which is not unlike the bullwhip effect, is generally bad for incumbent operations, but in some cases it also provides an opportunity for innovation. Who knows what the next hottest liquor will be?

Bottlenecks at Boeing. Operations Clash with Finance?

Photo: REUTERS/Jason Reed

Reuters is bringing an interesting article (h/t Cameron Zuroff) about operational issues and financial pressures at Boeing (NYSE:BA).

Boeing is struggling to cope with the 787 production schedule, after the production ramp up to 10 planes per month late last year. The bottleneck seems to be fuselage complex wiring done in their South Carolina plant. But the bigger picture is that Boeing has committed to deliver 10 planes per month and missing the schedule would involve steep penalties. What does Boeing do? They send half ready components to the factory at Everett for rework and final assembly.

To me this is an example of clash between operations and financial goals:

Boeing’s ability to churn out the Dreamliner is crucial to its financial performance this year as the company is relying on commercial jetliners to offset a weak defense business. While Boeing still loses money on each 787 that it builds, it gets closer to breaking even as production increases.

Cash flow from the 787 is expected to improve next year, provided the factories stay on pace, Boeing said. The cash is needed to fund new plane development, as well as fulfill investors’ desire for share buybacks and dividends.

Clearly, Boeing is between a rock and a hard place. They try to ramp up capacity in South Carolina, hire temporary workers, but that leads to higher cost, further delaying the break even point. Sending “pre-routed” components to Everett, is also a questionable move. From the classical quality management standpoint, defects should be fixed immediately after they are detected. Unless there is an excess capacity at Everett that would allow to finish work quicker than it would have been done in South Carolina, sending half ready components would only delay the production.

One thing is evident. Learning curve for the new 787 production turned out to be steeper than originally thought. All the pressure is now on Boeing to catch up with it.

Is an event unfolding before our eyes?

In Operations Management, as well as some other fields, researchers like to study how people react to various announcements or events about a company. This is called an “event study”. Typically in such studies, the wisdom of a crowd is captured through the price of a company’s stock to which an event is related. Of course, the company needs to be big enough and traded on an exchange. My colleagues Vinod Singhal and Kevin Hendricks have done a lot of work on these studies. In that sense it is interesting to watch what is happening to Boeing now.

Their newest development, the 787 Dreamliner, has recently shown some quality glitches . Here’s how CNN portrayed the story on Wednesday:

Over the course of Monday and Tuesday, when two announcements about a fire in 787 auxiliary battery, and a fuel valve leak were made, the stock price of Boeing plunged about 5%, which is a lot. More interesting things happened later in the week though.

Does it make sense to bring jobs back? The case of Apple.

Apple is making highlights today with their decision to resume limited manufacturing in the US. Surely it will generate some good publicity. No longer than 2 years ago, at a dinner with the Silicon Valley execs, Steve Jobs told President Obama responding to the question what would it take to manufacture iPhones in the States: “These jobs are not coming back”. Are we witnessing a reversal of the trend? My answer is — not really, but this case of backshoring does make some business sense. Here is why.

Supply chain realities

Think the days of the Bullwhip effect are over? Not at all. Here is a telling example from Russian aircraft manufacturing. As UAC tries to ramp up production of the SSJ 100 passenger jet, its engine supplier is struggling:

“We are facing difficulties with the supply chain. We need to fight every day [against Airbus and Boeing] to get priority,” PowerJet CEO Jacques Desclaux said, speaking at the ERA General Assembly in Dublin.

Desclaux explains that when Airbus and Boeing order 500-1,000 components, PowerJet struggles to secure slots for 100-500 parts. “It really is a challenge. There are not a lot of certified suppliers, so the choice is quite limited. The only thing we can do is to anticipate and place orders which are larger than we need,” he said.

There are two aspects to this situation. 

When should you not outsource?

Among the outcry about America losing its manufacturing jobs, two iconic companies, prominently featured in recent WSJ and NYT, prove that manufacturing is still possible in the good-ol’-America. One of them is Harley Davidson, the maker of big smooth-riding bikes, the other is Watermark, Brooklyn-based manufacturer of high end bath faucets. Both of them face stiff competition from Asia. Both of them could outsource, but did not. Why?

The answer is, of course, in understanding their strategies and core competencies. Harley is an American legend for more than 100 years. And so is Watermark, boasting its Brooklyn chic design. This is what the customers are willing to pay premium for! Ironically, many of the customers are in Asia. China with its growing highway network is getting a taste of riding, and liking it better on a Harley; the builders and buyers of luxury condos in Shanghai prefer to have unique faucets from Brooklyn. Going through the recession neither of the companies made a move to make their products cheaper. High price together with their “Made in USA” brand are driving demand for them.

It does not mean that companies did not have to trim some fat in their operation. Harley streamlined their production process, cutting workforce by 2000, but at the same time making sure that the remaining 1000 are better trained and flexible enough to perform multiple operations. Their inventory is down and production volume can be adjusted relative to demand. Some clever technology is in use at Watermark as well: 3D printing is used to speed up prototyping and cut lead times.

Now, could they have done the same overseas? Quality and quantity-wise – probably, yes. Would they be able to market their products so well? Probably, no. Interestingly, even Apple has “Designed in California” brand on their product. Had they have to drop it, by how much would they have to reduce their price?!
And since it’s Friday, I can’t help but notice another, rather peculiar, commonality in their day-to-day operations. Both companies routinely submerge their products in the water. That clearly better be done here in the States!

How do you build a 737?

I’ve written before about the Boeing plant in Renton, WA. Here is a fascinating video about how an airplane is actually built, this one is for Russia’s S7 airlines. The 11 days of final assembly  compressed in 2 minutes (and they do have a conveyor belt for airplanes!)

After a little bit of research, the details on the assembly line:

Length of moving line: 742.5 ft. (226 meters)
Speed of moving line: 2 inches (5 cm) per minute (75 hours to go through the line)

Read on, the performance improvement numbers are fascinating –>

How to counter demand variability?

Very timely comes this article about the Beer game and our favorite trillion-dollar-company-to-be Apple. The Beer game is a board game where the idea is to simulate a (beer) supply chain. It seems pretty simple – in order to fulfill the end demand retailers have to order inventory from wholesalers, wholesalers – from distributors, and distributors from factory, that produces beer. Each level has to decide how much to order or produce based on their demand. Things can get out of whack pretty quickly – a small increase in end consumer demand usually leads to inventory shortage at the retail level and that drives up the ordering quantity. Wholesalers facing increased demand, also start having backlog and increase order sizes even more. When the demand hits the factory, it has to produce crazy amounts to satisfy it…

All of this is the classical Bullwhip effect… One of the reason for it is the delay between the moment when the order is placed and when it is delivered. If the delay is shorter, supply will be matched with demand quicker and inventories will be reduced. How is this all related to Apple?

Jobs creation in the Apple ecosystem

Being the largest public company it is hard to avoid scrutiny of business decisions. The story has begun a couple of months ago with the series of articles about work conditions at the Apple contract manufacturers in China and the impact of Apple’s outsourcing on the US economy. So here comes another batch of numbers related to the Apple’s jobs creation, this time from Apple itself.

Labels and supply chains

Interesting information you can get from reading product labels. And I am not talking about food ingredients. What I am talking about is how long does it take from the moment a product is manufactured until it is sold? Or even, how long can a manufacturer afford this lead time to be? Lead times are tricky and rarely reported by firms. Longer lead times mean more working capital and pose challenges for forecasting, because firms have to decide how much to produce well in advance. In fact, in this paper I argue that retail sales forecasts (and inventory budgeting) for the next year are done 6 to 12 months before it starts. Anyways, because lead times are so tricky, I always welcome first hand data that documents them.

In this case the data comes from two product labels – one from Ikea and the other is CB2. Both related to furniture bought by me in the beginning of February. It turns out that Ikea manufactured that product (it was a chair) on May 26, 2011 in Mexico. Moreover the cover for that chair was made on the 16th week in 2011 (that is around Apr. 20). The chairs from CB2 were made in Taiwan by vendor Elegant Products and shipped from there on Aug. 4, 2011. Which gives almost 9 months lead time for Ikea and 6 months for CB2. Again these are the lead times after the product is manufactured. Actual decision about manufacturing them had to be done before that.

Give or take, it seems that Ikea’s lead times are about 50% more than CB2’s. And it makes sense, given that Ikea’s assortment rarely changes (aside from seasonal items) and CB2 tries to follow the contemporary trend.