Brought to you by Mark Childs – Capacity Commercial Group

OK, I’ll admit that I stole that phrase from Fred Bruning, a very gifted retail developer that actually has 3M sf of retail under development in the Western US, even during these challenging times.  I obviously thought that it was an appropriate title to this Quarter’s report, as we are constantly being battered with both good and bad news on a daily basis (noisy) that seems to abruptly change our expected future for both good and bad (choppy). 

 I try not to make these “Economist” reports.  If you care about such things, you probably have numerous economic reports sent to you daily, including the Beige Book, whatever that is.  However, I will pass on a comment or two that I recently heard during a presentation by Economist John Mitchell, who reference said Beige Book.  After 15 minutes of detailed data slides, he summarized with a slide showing more than a dozen factors that could cause the economy to go north or south (there’s that noisy and choppy thing again).  To highlight just a couple of data points, on a National level 2011 saw GDP increase by 1.7% and employment about the same.  Of the 47 states experiencing job growth last year, Oregon ranked 46^th.

 Portland Industrial continues to follow the national economy.  We saw 1.5% absorption of space last year, and have started this year with 655,000 sf of 1^st Quarter net absorption, exactly 25% of last year’s total.  However, while in the past I have rationalized that the absorption was MTM, sales, or possibly random large subsidized transactions, the absorption of leased space is now real, mid-size local companies that are stepping out.  We’re still just stepping out at an annual rate of 1.5%, but it is now a solid base to the slow growth.  The largest transaction was a 120,000 sf lease to Organically Grown in East County, while Pacific Foods will be leasing more than 200,000 sf in Wilsonville (not reflected in this quarter’s data).  Both companies will be vacating space for a reduced net absorption.

 The submarket statistics are attached.  I’ll save my submarket conversation for another newsletter.  Please send me an email if you have questions about your neighborhood.

 Leasing across the market continues soft, although there is tightening in some submarkets.  Classic 20 – 30k sf warehouse leases are still in the low $0.30’s, but now you can’t be so sure that you’ll get one month free for each year of lease term, and the TI allowance is tightening up.  Vacancy in Tualatin is down to the structural rate (only cats and dogs remaining) for many product sizes.  Further, there is almost a complete absence of spaces above 150,000 sf.  Landlord’s are working deals with their tenants to relocate them, or are just avoiding renewing smaller tenants to be able to create contiguous spaces larger than 200,000 sf.  The quantity of smaller spaces is keeping lease rates suppressed, while it takes lease rates in the high $0.30’s to justify the construction of larger footprints (over 200,000 sf).  Building 300,000 sf spec in Portland is gutsy, especially since it is so easy to visualize the analogy of a beautiful new beige warehouse looking like a white elephant.

Market Reports 1Q12

Three major changes over the past decade have created a need for manufacturers to radically change their approach to procurement.

 First, raw material and energy (RME) costs have increased 150% since 2000 while the CPI has increased less than 30%.

This dynamic has squeezed the margins of most manufacturers.  

U.S. Department of Labor - Bureau of Labor Statistics

Second, the volatility of commodity prices, which make up a large portion of RME costs, has doubled.

U.S. Department of Labor - Bureau of Labor Statistics

Finally, labor productivity gains have reduced labor cost as a percentage of total costs, making RME a larger component of the manufacturer’s cost structure.

The bottom line: Productivity gains made by manufacturers over the past decade have been largely offset by higher RME costs; RME costs make up a much larger piece of the cost pie and profits are more volatile due to greater swings in input costs.

In today’s world of more expensive and more volatile RME prices, businesses with exposure to commodity inputs must radically change their procurement model to merge buying and selling systems, develop the best hedging options and manage the gross margin in addition to costs.

For manufacturers to thrive in today’s environment they should develop three key areas:

• risk management systems that incorporate RME price risk
• hedging strategies and tools that help manage price risk (a hedge is an action that protects against adverse price movements)
• margin management systems that link buying with selling and extend past the bid or proposal stage

Risk Management systems should address how to manage price volatile RME inputs with sales prices that are difficult to increase. Analyzing price risk, defining price risk tolerance and developing a system to manage the risk within the established tolerance are essential to prudent operations at manufacturing and distribution companies.

Exposure or position reporting is also an essential building block to a risk system. Position reports link the units of input bought with the units of output sold. Net exposure, your “long or short” position, is where your price risk lies. Understanding the cost drivers of your inputs and their price volatility will help you establish “position limits” that adhere to the company’s risk tolerance.

Exposure management and quantifying risk tolerance are the foundation for the other two areas essential in changing the procurement model – hedging and margin management.

Hedging strategies and tools based on the company’s risk tolerance define what tools are appropriate to hedge your price risk.  This risk can be held internally or passed on to customers, vendors and third parties.  Key items to consider while developing hedging tools include administrative complexity, staffing requirements, capital needs and industry sophistication.   Hedging tools can be simple, like escalators in a sales contract or minimum/maximum quantities on supply contracts to very complex options strategies or over the counter instruments tailored to very specific risk.

Analyzing your price risk hedging options will provide unique insight into your business.   If a risk is difficult or expensive to hedge your focus needs to turn to eliminating units of exposure to that risk.

Tangible benefits are derived from  developing exposure systems, defining risk parameters and creating hedging strategies and tools.  You will improve procurement skills, buy better and reduce your price exposure to RME.

Margin Management systems link the position and price risk for a company’s inputs and outputs.  They include exposure reporting, earnings forecasts and scenario planning. Margin management uses risk management systems and hedging strategies to protect and enhance margins while connecting the procurement, production and sales functions of the company.

Here are some warning signs to help you identify if your risk and margin management systems need revamping:

• Your organization spends more time managing costs than margins

• Your organization does not have a method to measure RME price risk

• Sales decisions are made independent of buying decisions and vice versa

• “Higher RME costs” frequently explain away earnings shortfalls

• Your organization has a separate department called procurement or purchasing

• “Risk Management” mainly refers to the relationship you have with your insurance broker

• “Hedging” conjures up the image of expensive, complex transactions that are to be avoided

To compete in a global economy manufacturers must adapt their procurement system to today’s environment.

Please contact me if you are interested in learning more  about how these systems and tools will help your business.

Yours in better business,

Steve Rosvold

Steve@KRMBusinessSolutions.com

(360) 695-8605

By: Rick Pay
The R. PAY COMPANY, LLC
503.780.2014
rickp@rpaycompany.com

David vs. Goliath

Several authors have asked a very simple question: how can the little guys beat the big guys so soundly? In Part I of this Executive Briefing I used the German defeat of England and France at the Battle of Dunkirk as an example of how smart strategy may be more important than size and firepower. To look at business examples, how did Dell beat IBM and HP? How did Wal-Mart best Sears and JC Penney? John Boyd, who designed not only the F-15 and F-16, but also the first Gulf War strategy, began asking this question in 1952, and found four things that the German army did that successful companies like Dell and Wal-Mart do as well.[1],[2]

1)    Have a clear mission. A mission is an agreement between top management and the rest of the company on a target state. The target state itself is not a goal; it’s a state of being. For the German army, the target state was world dominance. Their mission was to beat the British and the French. As a leader, do you have a clear mission for your organization? Do people understand why they are doing what they are doing?

2)    Teamwork. This comes through training and experience; people working/learning together. In your Lean initiative, what kind of training do your people – at all levels – receive? Are they learning from their experiences?

3)    Decision-making. For the German army, decision-making became intuitive based on training and experience, which made decisions on the battlefield easier and faster. Also, decisions were made at the lowest levels by tank commanders in the field, not lawmakers or generals. There was extensive communication so that top generals were rapidly made aware of developments, but generals were there to support the decisions made in the field, so long as they were in line with the strategy and the mission.

One of the main reasons Lean is failing in American companies is that top management isn’t willing to give up decision-making power. It takes a high degree of trust. Oftentimes leaders can’t bring themselves to trust their teams to make the key decisions needed for day-to-day action.

4)    Strategy. This provides the focus and direction. It’s the game plan.

Mission, teamwork, decisions made at the front lines, and strategy. I emphasize these concepts with my clients whether they’re doing Lean or not. One of the first questions we ask about any improvement initiative is, “Do we need improvement, or do we need to eliminate this process entirely?” If you proceed directly to Six Sigma, Lean, the 5 Whys, Theory of Constraints, etc. without asking whether you really need those tools, you risk wasting a lot of time and energy. We need to understand the process – and find out if perhaps there are elements that don’t need to be done at all – before we begin deploying improvement methodologies.

Lean Strategy

The Toyota Production System is more than just tools, cost reduction (cost reduction is an outcome, but not an objective), and waste reduction. Taiichi Ohno’s book[3] is about speed: reducing cycle time from order to delivery while maintaining high quality at the lowest possible cost. It takes Toyota less than two years to design a new car and begin production. General Motors, in contrast, requires three to four years. By providing exactly what the customer wants in the shortest possible time, Toyota creates extremely happy customers and a clear competitive advantage. Quality and cost are important, but speed is the key.

In a competitive marketplace, other companies can copy your design, they can emulate process improvement, but they can’t replicate speed or culture, and that is how you can stay ahead of the pack. Likewise, anyone can implement the lean tools to reduce costs or improve quality, but not everyone can get faster or establish a culture of continuous improvement.

Toyota is happy to give tours of their factory because they know that even if outsiders see the inner workings of their production facilities, few can copy their speed or culture because American managers can’t let go of the reins and trust their employees to make decisions. Just like the German tank commanders, if supervisors on the factory floor aren’t allowed to make decisions or respond to day-to-day events, the pace of production will remain slow and opportunities for innovation are missed.

Strategy is built on the following elements:

1)    Vision – communicating a target state.

2)    Getting the right people in the right positions, particularly supervisors, managers, process engineers and others who design business processes. This includes getting rid of the wrong people, who can be like a cancer in the organization.

3)    Agility – the ability to quickly move from one strategy to the next as situations change.

4)    Speed – execution, time to market, cycle time, etc.

As a leader in a Lean environment you have a lot to do. If there is one thing that can serve as a unifying factor in determining your operations strategy, let it be your customers. You can communicate a compelling mission, develop strong, cross-functional teams, push decision-making down to the lowest possible level, and foster a culture of continuous improvement, but ultimately these things won’t matter without steady attention on the customer. Strong leadership combined with constant focus on the value you provide your customers adds up to competitive advantage.

[2] Richards,
Chester W. Certain to Win: The Strategy of John Boyd, Applied to Business.
[Philadelphia, Pa.]: Xlibris, 2004. Print.

[3] Ōno,
Taiichi. Toyota Production System: Beyond Large-scale Production. Cambridge,
MA: Productivity, 1988. Print.

© 2012 – Rick Pay – All Rights Reserved