Levi Strauss: SAP rollout 'substantially' hurt quarter

SAP implementation problems prevented Levi Strauss from fulfilling orders for a week during the second quarter of this year.

These shipping problems, combined with other economic issues, caused the company's net income to drop 98% relative to the same quarter in 2007. Levi's most recent 10-Q SEC filing states that negative effects arising from the implementation "constitute a substantial portion of the decrease in the region’s net sales in the second quarter as compared to the prior year."

The company has been deploying SAP in staged releases around the world since 2003. A Levi's spokesperson told me the company launched its US-based ERP initiative this spring, and experienced difficulties connecting and integrating various legacy systems:

We ran into technical issues going through the implementation process, which interrupted shipping for about a week. We experienced shipping delays as we ramped the system back up, resulting in lost orders.

Although Levi's has not disclosed much detail about the problem's causes, the company's SEC filing offers clues:

We are currently implementing an enterprise resource planning (“ERP”) system on a staged basis in our subsidiaries around the world. We implemented the ERP system in several subsidiaries in our Asia Pacific region prior to fiscal 2008. During our second quarter of 2008, we implemented the ERP system in the United States resulting in changes in our system of internal control over financial reporting. Certain controls that were previously conducted manually or through a number of different existing systems were replaced by controls that are embedded within the ERP system, resulting in an update to our internal control process and procedures, the need for testing of the system and employee training in the use of the new system. Subsequent to the U.S. implementation, we encountered issues with the U.S. ERP system which caused us to further revise our internal control process and procedures in order to correct and supplement our processing capabilities within the new system.

The changes described above materially affected our system of internal control over financial reporting during our last fiscal quarter. Our current system of internal controls over financial reporting continues to provide reasonable assurance that our books and records accurately reflect our transactions and that our established policies and procedures are followed.

Francine McKenna, a former PriceWaterhouseCoopers consultant and auditor, interpreted the SEC filing for me:

It's serious stuff. The language suggests that fundamental internal control errors were discovered after the system went live. Apparently, auditors determined these problems could have resulted in a materially significant impact to Levi's financial statements if not corrected. I can speculate that perhaps it was inventory related, because it's the big balance sheet item for a company like this.

Also, given Levi's previous errors and restatements, and with the recent change in auditors, new auditor PwC is probably taking a very strict approach to assessing Levi's efforts to implement SAP with required controls.

The filing suggests that Levi's anticipated potential ERP problems:

In anticipation of that implementation, we provided advance shipments to wholesale customers in the first quarter of 2008 that would normally have been shipped in the second quarter. Our ability to fulfill customer orders in the second quarter was subsequently impacted by issues encountered during stabilization of the ERP system.

The implementation is currently in a "stabilization period" and Levi's believes the worst is over:

Throughout the ERP system stabilization period, which we expect to last for the remainder of the year, we will continue to improve and enhance our system of internal control over financial reporting. We plan to implement the ERP system in other subsidiaries in the coming years and we continue to believe that the ERP system will simplify and strengthen our system of internal control over financial reporting.

THE PROJECT FAILURES ANALYSIS

Levi's hasn't released much technical detail regarding what caused the order fulfillment difficulties; given this lack of information, it's hard to draw conclusions with any level of confidence.

Nonetheless, a one-week shipping interruption is serious by any measure. Although Levi's apparently anticipated potential go-live problems, the severity and depth obviously took the company by surprise.

One analyst quoted by CIO magazine in 2003 questioned Levi's overall project timing:

Levi’s is bucking the industry-wide trend by going ahead with ERP now. "It’s expensive, high risk and requires a lot of cultural change, and unless you have a really compelling reason to do them you don’t [during a downturn]," says Paula Rosenblum, an AMR Research analyst.

It's interesting to note that Levi's former CIO has quietly disappeared from the scene. From the Guardian:

David Bergen, Levi's chief information officer, who came on board eight years ago to reconcile the company's hodge-podge of systems to a SAP-centric one, has quietly left Levi's. No announcement was made at the time and no reason is given for his resignation by the company.

Devil's triangle relationships. Virtually all large ERP implementations involve three parties, which I call the devil's triangle: software vendor, customer, and at least one third-party implementation services provider.

The complex and interlocking set of business and technical agendas governing these relationships can make failures difficult to dissect accurately. Of course, the parties usually don't want to discuss their failures in detail, which also makes full analysis hard.

In this case, Levi's is the customer, SAP the software vendor, and Deloitte appears to be the primary implementation partner. Levi's responded to my question about Deloitte's role:

A number of business process and systems integration experts have supported our ERP implementation. This included Deloitte among others.

SAP and Deloitte were associated with another recent high profile IT failure: the Los Angeles school district's (LAUSD) morale damaging problem printing paychecks. Regarding LAUSD, I offered the following comments to SAP, which likely apply here as well:

SAP...something has gone very wrong and you’re the ultimate experts. It’s high time you crossed some boundaries and pushed Deloitte harder.

Experience studying implementation failures suggests Levi's also played a contributing role in this situation. Since the company presumably follows a standard methodology for all rollouts and has successfully deployed SAP in other regions, something different happened here. Although we can only guess, perhaps the differences relate to unexpected complexity in the financial environment at Levi's company headquarters or in project management issues unique to the US rollout.

Regarding current status, Levi's spokesperson said, "Although more work remains, we're back to shipping at customer demand levels."