The supply chain wars

Tyco raises the white flag in the face of soaring resin costs and customer demands for price reductions.

Tyco International, which buys some 1.5 billion lb of polyethylene annually, is losing a battle to dramatically improve its cost structure in plastics and plans to exit the business.

The company is caught in a classic supply chain squeeze play with soaring resin costs on one side and price-fighting big-box customers on the other. Competition from China was another significant factor, particularly for its A&E Products Group, a huge injection molder of garment hangers.

Still recovering from a financial scandal, Tyco announced in May that its fiscal second-quarter earnings nosedived 75% because of higher commodity costs, notably resin, and weak automotive sales in Europe. Revenues for Tyco''s Plastics and Adhesives unit rose 8% in the quarter, but recorded an operating loss of $187 million. Tyco also wrote down the book value of its A&E hanger unit by $202 million. Tyco hopes to sell Plastics & Adhesives in the next year. Efforts to peddle the business 4 years ago flopped because of feeble interest.

Tyco installed a new management team in plastics in the past 2 years, and it launched major efforts to reduce costs through improved supply chain management, purchasing, and restructuring. "All these initiatives combined to create nearly $45 million in savings," comments Terry A. Sutter, president of the business. "In terms of cash flow, we achieved a 14% improvement in working capital days."

In late 2003, Tyco''s plastics plants operated at only 73% of capacity. Tyco shuttered nearly 30 facilities that represented about 2 million sq ft. Production lines that handled 100-million lb of product were relocated. Then the resin price hammer fell last year: Price tags for polyethylene, polypropylene, and polystyrene (its three most important polymers) jumped more than 50%, increasing Tyco''s resin costs by about $50 million. Tyco officials expect price pressures to continue because of tight supply/demand balances at the producer level.

Tyco is one of the largest suppliers of polyethylene packaging films in North America, with 15 manufacturing plants. Its products include Ruffies trash bags, Tufflite agricultural films, Big City linear low-density polyethylene (LLDPE) can liners, Rhino-X high-density polyethylene (HDPE) can liners, polystyrene and polypropylene cutlery, LLDPE clarity food bags, Film-Gard plastic sheeting, and high-clarity shrink films. Revenues in those businesses grew from $871 million in 2002 to $965 million in 2004. Major customers were supply chain juggernauts like Home Depot and Wal-Mart.

A major unit in the Tyco Plastics and Adhesives business unit is A&E Products LP, the global leader in garment hanger manufacturing, producing more than four billion/yr. A&E''s revenues dropped from $322 million in 2002 to $251 million in fiscal 2004. "Expansion outside of the United States is key for our A&E business, having added more than 50 people in our new office in Hong Kong," Sutter says. In fact, the unit moved its headquarters to Hong Kong last year. Managing Director Felix Chim said the relocation was dictated by customers who wanted more presence in Asia. Resins used by A&E include polystyrene, polypropylene, and K-Resin styrene-butadiene copolymer. In another sign of its drive to low-cost countries, A&E opened a new manufacturing plant in Sri Lanka with a capacity of 300-million hangers/yr.

Overall Tyco has reported rapidly improving earnings since Ed Breen became CEO in July 2002, succeeding L. Dennis Kozlowski, who faces a possible 25 years in federal prison for allegedly looting more than $150 million from the coffers of the Bermuda-based conglomerate. Breen has received Wall Street raves for rapid earnings improvement from his campaign to boost "operational excellence" through three supply chain initiatives: strategic sourcing, Six Sigma, and working capital. Tyco expects to report more than $550 million in net savings from strategic sourcing efforts in 2004 and 2005.

Tyco built an enterprise-wide data warehouse through Ariba to identify all spending by the highly decentralized business units. The goal of the strategic sourcing effort is to identify where that spending can be grouped to build leverage among key supplier partners.

Those efforts have paid dividends in the Plastics & Adhesives business, but probably not at the same level as other units like Healthcare and Electronics, which had more mature sourcing organizations and a more sophisticated sourcing approach than is commonly found in the plastics business.

Sutter reports: "To survive in this price-competitive environment and to position ourselves for long-term growth, we''re partnering deeply with our suppliers and customers. Our strategic sourcing efforts have helped us purchase resin collaboratively across our business to ensure the most competitive pricing." But the unit''s biggest supply chain conundrum may be unsolvable: It''s stuck between two 800-pound gorillas-resin giants and the big-box behemoths.

Analysts question the timing of the proposed sale of the plastics business. Why not wait until resin prices slide again? "We think the timing is very good right now," responds Breen. We have significantly improved the factory footprint, which was the Achilles heel. The buyers will look past the resin market."

Time will tell.--Doug Smock