Inflation is Broad Based
As we near the end of the year, many supply chain executives will become embroiled in their firm’s annual strategic planning process. Before executives do that, it is worth reviewing the top trends that will be impacting supply chain management for the coming year and beyond. What follows are the top trends executives need to be paying attention to before their strategic planning meetings commence.
In the US, consumer prices were up 9.1 percent over the year ended June 2022. This was the largest increase in 40 years according to the U.S. Bureau of Labor Statistics. In Europe, it is worse. Preliminary data from last Monday – October 31st – reported Eurozone inflation running at 10.7% for October. This is the highest ever monthly reading since the euro zone’s formation.
For supply chain executives, this is a good time to start contemplating stock keeping unit (SKU) reductions (reducing the number of products and product variations manufactured). Sales departments frequently fight these reductions, but the inflation environment gives supply chain executives extra ammunition to power forward with these initiatives.
As customers become more price sensitive, it is also important to dig into products bills of materials and see if there are raw material and component inputs that are particularly responsible for driving higher product costs. Can the product be redesigned with lower cost substitute inputs?
The Pending Recession
Central banks respond to high inflation by continuing to raise interest rates – and thus slow economic growth – until inflation is back to acceptable levels. In the US, an acceptable level of inflation is defined as 3% or less. Often, but not always, rising interest rates tip a nation into recession. However, with inflation at such high levels, the chances of a “soft landing” – bringing inflation under control without tipping the country into recession – are very small.
There is a playbook for companies facing a recession. It is difficult to forecast dropping demand. The signals tend to lag what is happening in the market. Inventory write downs are common. Companies also tend to be slow to cut production. So, if a recession appears likely, companies need to error on the side of a conservative forecast, be prepared to lay off workers sooner rather than later, and start drawing down their safety stock inventory. Companies that can monitor downstream demand signals and use that data to make more frequent forecasts will see their forecasting accuracy improve much faster than companies using traditional forecasting methods.
Many companies work to conserve cash by paying their vendors more slowly. This needs to be done carefully, a company needs to make sure they don’t force their key vendors into bankruptcy. Meanwhile, supply chain risk management solutions can be used to monitor the financial health of upstream vendors so that alternative sources of supply can be secured promptly if key vendors are in trouble.
Employee wage increases, turnover, and retention have been big stories all year. Employee demands for higher wages are apt to increase as inflation surges and the workers’ spending power decreases. At the same time, as companies face a coming recession, they don’t want to lock in higher wages at exactly that point in time when the companies’ customers are becoming more price sensitive. This will be difficult to navigate.
China is Not a Dependable Partner
At the beginning of October, the Biden administration published a tough set of technology export controls. These controls included a measure to cut China off from certain buying semiconductor chips made anywhere in the world with US tools. The US is greatly expanding its attempt to slow Beijing’s technological and military advances. It is not just US tool manufacturers that are affected. Both American and foreign companies that use US technology are being required to cut off support for some of China‘s leading factories and chip designers. The goal is to set China’s chip manufacturing industry back by at least a decade.
When the US agreed to a free trade agreement with China in 1999, the theory was that as more and more Chinese entered the middle class, China would become more democratic. That did not happen. What happened instead was massive theft of intellectual property, huge trade deficits, the hollowing out of the middle class in Europe and North America, and the rise of nativist politics.
China, of course, is likely to react to these measures in ways that may be hard to predict. However, trade barriers are apt to increase. We are beginning to move from a world of “free trade” to one of bilateral trading blocs. In this new world, democracies will increasingly do business with each other. Similarly, dictatorships and pseudo democracies will increasingly trade with each other.
Honda’s actions provide one example of this. It was reported, much to the company’s embarrassment, that the automotive manufacturer is risk-hedging its Chinese supply chain. Honda will have one supply chain to support the Chinese domestic market, while building a separate supply chain for markets outside of China. When it comes to building new factories, the term “ABC” is being used – anywhere but China.
The N-Tier Supply Chain
All the COVID supply disruptions brought home the need for better supply chain risk management. Risk management had been a hard sale. Multinationals knew that events could occur that could cost them tens, or hundreds of millions of dollars. But these events were not predictable. And many individual events that could occur were so rare they were labeled “black swan events.” The upshot of this is that companies could not calculate a return on investment on improving their risk management capabilities.
Companies typically embrace improved supply chain risk management after the horse had already fled the burning barn. For example, the auto industry embraced risk management after the nuclear disaster at Fukushima. COVID was a Fukushima category event that applied to all industries.
But as companies embraced advanced risk management solutions, they discovered that while some of these solutions were very good at identifying risks in real time one tier up in the supply chain, they could not identify risks occurring several tiers up in the supply chain – the so called “n-tier problem.”
McKinsey did a survey in which just under half of the companies in their survey said they understood the location of their tier-one suppliers and the key risks those suppliers face. Astonishingly, only 2% had visibility to their suppliers in the third tier and beyond. That matters because many of today’s most pressing supply shortages, such as semiconductors, happen in these deeper supply chain tiers. Becton Dickinson, like most other companies, had many supply chain problems because of COVID. Around 80% of this global medical technology company’s disruptions were the result of problems in the n-tier supply base, not their Tier 1 suppliers.
Discovering who the n-tier suppliers has historically been difficult, time-consuming, and far from accurate or complete. That is because this was a manual process that depended upon cooperation from upstream tiers of suppliers in the discovery efforts. Many upstream suppliers are suspicious of this “prying.”
However, there is now a technological fix. Everstream Analytics has proven that with the combination of vast amounts of data, graph databases, and artificial intelligence, they can do the difficult job of identifying these n-tier suppliers with much less effort and better reliability.
Governments are increasing their demands for companies to prove that they operate sustainable and ethical businesses. In January 2023, the Germany Supply Chain Due Diligence Act will come into effect, requiring businesses to monitor supply chains for human rights violations and ensure that partners are not causing environmental degradation across their entire supply chain – the n-tier problem again. There has been supply chain legislation before whose goal was focused on making sure various aspects of ESG (Environmental, Social, & Governance) performance were enforced by companies. But supply chain practitioners have never seen compliance legislation that was so broad and impactful. In the past, this kind of ESG legislation was focused on a specific risk domain, like child/forced labor or the 2020 Uyghur Forced Labor Act. Now we are seeing a move to all-encompassing ESG legislation with significant penalties – fines can be up to two percent of annual sales. Perhaps as bad as a fine is the brand damage that could result if a company is prosecuted.
Germany has the fourth largest economy in the world, so many multinationals will be affected by this. Multinationals might contemplate moving a regional office out of Germany to avoid this. That won’t work. The European Union has similar legislation moving forward that may come to fruition in about a year and goes even further than the German Act.
Greenhouse Gas Reductions
PwC reports that almost half of assets under management are held by investment firms committed to decarbonization. Investor concern about material risks from climate change have created new reporting frameworks, such as those by the Sustainability Accounting Standards Board (SASB) and the Task Force on Climate-related Financial Disclosures (TCFD). So, it is perhaps not surprising that not a week goes by without some big company either making a pledge to eliminate carbon emissions by 2040 or 2050 or documenting their progress on this journey. In some industries, 90% of emissions occur in the supply chain. Clearly, achieving sustainability goals will require the participation of a company’s supply chain teams.
Sustainability is a very big topic, but a few points are worth making. First, the more digital a company’s supply chain is, the more efficiently that company produces goods. Efficiency in matching supply to demand, manufacturing products, and transporting gools all lead to lower emissions.
Secondly, companies with sustainability targets usually allow sustainability projects to have a lower return on investment. For a supply chain executive looking to improve the technology their group uses, those two facts mean it may be easier than ever before to get funding for supply chain technology.
Thirdly, our tools for collecting, cleansing, and reporting emissions are still somewhat immature. But progress is being made. At Oracle’s recent CloudWorld, the company’s efforts to improve their software’s ability to report on emissions, and other ESG goals, was discussed. Oracle’s reporting and planning solution allows companies to collect and standardize emissions data from multiple sources and manage all their sustainability data in one place. Once a baseline is established, organizations can model short and long-term sustainability goals, align initiatives across their operations, and make decisions based on an integrated understanding of sustainability, finance, and operations.
Finally, when it comes to emissions reductions, there is a lot of low hanging fruit in the supply chain realm. Currently, companies can make progress on emissions while saving money. But within a few years, that will no longer be true for many companies. At that point companies will need to trade off achieving emissions goals with higher costs. That will be the point in time when we learn how serious companies really are when it comes to reducing greenhouse gases.