Category: Economics

Starbucks Borrows ‘Lean’ Page from Toyota

As The Wall Street Journal reports in “Latest Starbucks Buzzword: ‘Lean’ Japanese Techniques,” the coffee giant is adopting one of the auto giant’s most successful management practices as it combats the economic downturn. In lean manufacturing (known as the Toyota Production System until the 1990’s), any activity that doesn’t ultimately add to the value of the product is wasteful. This can be anything from moving a part around a factory excessively to locating various production processes inconvenient distances from each other.

In the case of Starbucks, waste takes the form of excessive moves about the store, waiting for timers to expire or brewers to finish, and lifting items from under-counter storage. Even the barista who once stood guard behind the pastry case, awaiting only pastry orders and taunting the coffee purchasers, has been eliminated. Speaking from personal experience, I never much saw the point of having a barista perform such a limited task, even when I did order food with my caffeinated creation. The company is even hoping that decreasing the distance a barista moves for the various components of a drink will increase productivity and reduce the number of baristas needed for each shift. But, given how little a barista moves from the espresso machine now (with exceptions, of course—see below for how this is changing), I wonder how much efficiency the company can find there. Nonetheless, if you’ve been in a store lately, you may have noticed some of the changes without realizing it.

As I mentioned, gone is the barista at the pastry case, generally. Lately, I’ve noticed that the barista making iced teas and Frappuccinos is largely responsible for toasting items as needed. Otherwise, the barista ringing up the orders is pulling pastry items from the case. This seems to free the barista at the espresso machine to focus on those drinks. I’ve also noticed containers for bulk ground coffee are now located next to the brewers, rather than below them, along with filters. Undoubtedly, items have moved behind the espresso machines, but I haven’t noticed anything so far. However, the new espresso machines, which the company is rolling out now, hold more beans and give the baristas more control over shot length and steaming, so presumably that should equal more efficiency by way of less wasted milk, espresso, and ultimately, time.

As a customer, I have to say that the few changes I’ve noticed are for the better. I can’t speak to how these changes have affected peak times or the bottom line, but if the company is confident enough to implement lean procedures in its 11,000 stores, something must be working.

Maybe with all the money the company is saving on this efficiency, it can work on putting together some better pairings. After all, I need more than a tall beverage in the morning.

Bank of America tries the Citigroup approach

Between Ken Lewis’ recent purchases and his comments during today’s press conference with Merrill Lynch Chairman & CEO John Thain, it appears to me that he is trying to build a financial institution in the same fashion that Sandy Weill did at Citigroup. During his opening remarks, Mr. Lewis mentioned building the “premier financial institution in the world,” language that reminds me of Mr. Weil. The size of the bank would speak to this tendency. Having added mortgages and private wealth management by way of Countrywide and U.S. Trust, respectively, Bank of America is simply plugging the holes at this point. LaSalle is further evidence, filling one of the largest holes in the bank’s branch network. For Mr. Lewis, his about-face on investment banking makes this purchase that much more curious. The quality of Merrill Lynch’s operations certainly sets this purchase apart because of the value it adds to B of A, apparently relieving the banks concerns regarding investment banking; the many other aspects of Merrill’s operations also make the purchase an attractive addition to B of A’s portfolio.

I was also happy to hear that B of A is committed to retaining the Merrill name and operations. With the number of ongoing integrations, Mr. Lewis doesn’t expect to begin the Merrill systems integration process until 2010 anyway.

Changing the Window Dressing

Yesterday’s announcement that the Treasury Department has blessed covered bonds for use in the mortgage market made me wonder if Wall Street and the government have learned anything from the credit crisis gripping the national economy. There are two distinct differences between the collateralized debt obligations (CDOs) that got us into trouble in recent years and the covered bonds as announced yesterday by Treasury Secretary Hank Paulson. First, rather than removing the securitized assets from the seller’s balance sheet, the assets remain in the issuer’s control, providing purchasers recourse against those assets. The second difference involves the types of mortgages that can be securitized in a covered bond. So-called “stated income” or Alt-A mortgages, as well as the notorious subprime mortgage, cannot be included in a covered mortgage bond. Beyond these two differences, CDOs and covered bonds are essentially identical.

The idea with a covered bond is that since the assets stay on the issuers’ balance sheets, they are less likely to take risks with the securitized assets. Additionally, the purchaser of these bonds has recourse against specific balance sheet items, a feature intended to limit the default risk associated with mortgage-backed securities. Unfortunately, these debt instruments are still based on residential mortgages, an area of the US economy showing substantial weakness in the foreseeable future.

While intended to provide more liquidity to the mortgage market, covered bonds still rely too heavily on the CDO model. It seems unlikely to me that the minor differences noted above will instill enough confidence in the market for these instruments to have any impact on mortgage availability.

My other concern with covered bonds regards insurance. Bond insurers, having suffered greatly over the past year, are not in a strong position to offer insurance on covered bonds. Given that covered bonds provide recourse, the utility of bond insurance is further reduced. Additionally, I, for one, see little value in the insurance offered by major insurers.

Ultimately, the success of these securities will depend directly on the quality of the underlying mortgages and the health of the US economy, both of which are quite uncertain now and in the near term.

Tanker Contract Reopened

As was expected, the Department of Defense yesterday announced it would reopen the bidding process on its $40 billion aerial refueling tanker contract. The move was widely expected following last month’s GAO report (see my post here) which found several significant deficiencies in the way the contracts were awarded. This announcement is welcome news for Boeing, which lost the contract to Northrup Grumman in February and immediately filed a complaint with the GAO.

In response to the GAO criticisms of the Air Force’s selection process, Secretary of Defense Robert Gates decided that his procurement director, Undersecretary John Young, will personally oversee the rebidding process. But, in what is certainly welcome news for Air Force brass, the Secretary said he doesn’t think that problems identified by the GAO warrant removing senior Air Force officials from their posts.

This newest round of bidding represents the third time the Air Force has sought a contract to replace its aging fleet of refueling tankers. On the first go around, Boeing received a no-bid contract to provide new tankers. Following widespread criticism and scandal at both Boeing and within the Air Force, the contract was reopened for bidding, which Northrup Grumman won in February. Then Boeing complained, and here we find ourselves. For the sake of American taxpayers, let’s hope the adage “Third time’s a charm” holds true.

Source: “Boeing Gets Chance to Wrest Tanker Job From Northrop,” The Wall Street Journal, July 10, 2008.

US Average Daily Oil Consumption

According to recently-released government data, the US is currently using an average of 9.347 million barrels of oil per day.

CORRECTION: According to the Department of Energy’s Energy Information Agency, the above figure of 9.347 million barrels per day represents gasoline consumption only. During the same period, overall crude oil consumption was 20.253 million barrels per day.

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Well That Didn’t Take Very Long

Just weeks after indicting two Bear Stearns hedge fund managers for securities fraud tied to the credit crisis, The Wall Street Journal today reported that federal prosecutors are investigating the auction-rate bond market. In particular, the US Attorney’s office for the Eastern District of New York is looking at two Credit Suisse brokers and whether or not they misled investors about the assets backing the securities they purchased.

Very little about this story is surprising, given the failure of the auction-rate market in February. This is just the latest legal fallout from the credit crisis Bear Stearn’s started last June. More announcements like this are almost certain as the current economic turmoil unfolds.

The Wall Street Journal article is titled “Auction-Rate Probe Grows Over Clarity From Brokers” and appeared on July 9, 2008.

Credit Crunch Knows No Bounds: Town Hopes to Secede

The credit crisis has had wide-ranging effects, from a shortage of mortgage funds to excess housing supplies to a lack of student loan money. But none seems stranger than the plight of a small, north England town. The town of Berwick-upon-Tweed, located on the North Sea, would rather be Scottish. Having changed hands 13 times in conflicts between England and Scotland, the town doesn’t necessarily identify itself with either country anyway. Its distance from London and proximity to the Scottish capitol Edinburgh further confuses the issue. And both countries haven’t always been sure where the town belongs; laws and other official dealings written in the 1500s cite the “Kingdom of England, Scotland, and Wales and the town of Berwick-upon-Tweed.” It is a combination of this uncertain history and the current economic malaise that pushes this small port town towards secession.

As it turns out, Scotland has better social welfare programs. The health care is superior, Scots’ university tuition is covered by the state, and the unemployment benefits are more generous. In a time of economic uncertainty, people increasingly look to the government for support, and the residents of Berwick would rather turn to Edinburgh than London. That the town has one of the lowest average wages in England and highest unemployment rates further sweetens the Scottish appeal. It doesn’t help that Berwick, being substantially closer to the Scottish capitol, feels that London is out of touch with its situation. Given these economic and political conditions, some Berwick residents are pushing for drastic changes.

Already this year, realtor Euan Aitchison has sold 25 Scottish properties to Berwick residents. Most of these properties are so close to the current border that it is no more than a 10 minute drive back to Berwick. This has allowed many of the transplants to maintain their jobs in England while simultaneously enjoying the benefits of Scottish residency. But if certain members of the Scottish and UK parliaments have their way, these efforts may soon be moot. A motion has already been introduced in the Scottish Parliament calling for the town to return to Scotland, while UK Parliamentarians have vowed to prevent the town from moving. Debate in both Parliaments is sure to be lengthy and contentious, even though 79% of the town’s residents support the border change. Even if the change is approved by the necessary legislatures, executing the move faces substantial hurdles. For starters, the English and Scottish legal systems are quite different, as are the educational systems. Nonetheless, the town’s residents are drawn to the idea by the benefits. A simpler solution may be to provide Scottish-style services to the residents of North Northumberland, as Berwick’s Liberal Member of Parliament Alan Beith has suggested.

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Major News Outlet Finally Says “We Just Don’t Know”

National Public Radio has “boldly gone” where no news organization has dared venture since oil prices began their historic rise. On Tuesday’s Morning Edition, host Renee Montagne and economics correspondent Adam Davidson discussed why no one, including the government body regulating commodities trading, can explain the runup in crude oil prices. Hear the full conversation, “Why Don’t We Know Why Oil Prices Are So High?,” at npr.org.

Outsourcing and Current Economic Conditions

With today’s announcement that 62,000 jobs were lost in the month of June, I wonder what impact this may have on the outsourcing trend of recent years. As The Wall Street Journal reported on June 13, rising transportation costs are leading some US companies to end their outsourcing practices. With the cost of shipping goods from Asia up roughly 15% this year, companies are increasingly returning production to either domestic facilities or nearby countries such as Mexico. These are exactly the kind of jobs our economy needs right now: manufacturing. The loss of these jobs has been a popular and sensitive issue for some time now, and this is early evidence of a change of course. Certainly welcome news for the 33,000 manufacturing jobs lost during the month of June. Will the continued backlash against offshoring solve the employment problem for the hundreds of thousands of unemployed factory workers in the US? No, but it certainly can’t hurt anything.

So it seems that there is a silver lining to be found even in current economic conditions. If companies continue to return their production to domestic facilities, not only will this provide manufacturing jobs, but also they could eventually need to expand their capacity, providing employment to the many construction workers hit hard by the housing and credit crises. Having lost some 43,000 jobs in June, the construction industry would certainly welcome increased factory construction. Typically, these commercial projects are more predictable and less risky, since large corporations are backing them, financing is generally in place and readily available, and projects tend to cover a longer time period. All of these things combine to provide some small measure of optimism to a battered construction industry.

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Congress Closes Loophole Allowing Private Security Contractors to Avoid Paying Employment Taxes

Last week, the President signed the Heroes Earnings Assistance and Relief Tax Act which, among other things, closes a loophole that has saved contractors in Iraq millions of dollars while simultaneously undercutting the Social Security and Medicare trust funds and the individual contractors. The Act requires that foreign subsidiaries of US companies doing business with the federal government pay employment taxes as if they were US employers if the parent company owns 50% or more of the foreign subsidiary.

In March of this year, The Boston Globe reported that KBR (formerly Kellogg Brown & Root, once a subsidiary of Halliburton Corp.) had managed to avoid paying employment taxes by hiring its contractors through shell companies based in the Cayman Islands. While this move has saved the Defense Department more than a pretty penny, it puts the Social Security and Medicare trust funds at a disadvantage due to the lost investable income. The Social Security and Medicare taxes in question total 15.3% of an employee’s pay, and are split between the employee and employer. The greater disadvantage, however, belongs to the employees of these overseas shell companies. Because KBR does not pay employment taxes on the contractors’ earnings, the wages are not reported to the Social Security Administration (SSA). As a result, the contractors cannot receive any future retirement benefits for their time as employees of these shell companies. This problem is magnified by the fact that the contractors are very well paid, which would have led them to put a larger portion of their paycheck into retirement savings. The Act provides these employees some relief, though nothing about the law is retroactive. The SSA will only credit the contractors for earnings that are properly taxed and reported to the appropriate federal agencies.

KBR isn’t the only contractor who took advantage of this loophole, but undoubtedly benefited the most. The company employed more than 20,000 contractors in Iraq through its offshore subsidiaries (Incidentally, the contractors also managed to avoid paying federal and state unemployment using this tactic). Subsequent Globe investigations revealed that DynCorp International and MPRI both hired their Iraq contractors through foreign subsidiaries. The practice, surprisingly, was not widely used by anyone other than Iraq contractors, but Congress still felt compelled to act.

As I said at the beginning, the foreign entities going business with the federal government will now have to comply with US employment tax laws if they are 50% or more owned by a US company.

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