How Cost Is Becoming a Supply Chain Design Decision

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How Cost Is Becoming a Supply Chain Design Decision

Photo:iStock.com/Dilok Klaisataporn

Around the world, businesses are increasingly treating cost as a design decision rather than a negotiation outcome. In many instances, the conversation is shifting from “How do I redesign this supply chain to bring the cost down” to “How should this supply chain be designed to deliver our new outcomes.”

Recently there's been much focus on the shifting dynamic for procurement. After two decades of deflationary environments marked by multiple supply chain disruptions, what tactics and behaviors need to change as cost structures around the world begin to rise?

The topic of redesign gathered some momentum during the pandemic. Resilience became fashionable, but paying for it didn’t become a trend. Resilience proved expensive, and once the immediate crisis faded, and markets began to stabilize, many businesses slipped back into optimizing for efficiency.

In hindsight, that stability was temporary. Probably those that made the greatest shift were the high-value supply chains like defense, semiconductors and pharmaceuticals, where governments acted to assure future prosperity and security. These were long-term plays.

Multiple Inflationary Forces

More recently, it’s easy to point to the ongoing crisis in the Middle East as the key driver of inflation, sending pricing and availability shocks through the system. But the new inflation model is much more complex than that. There are at least four inflationary forces at play:

Not all four forces affect every business equally. A food manufacturer might feel energy and freight inflation far more acutely than a software company. A defense manufacturer might willingly absorb strategic inflation in exchange for assured supply. The procurement challenge is therefore not simply managing inflation, but diagnosing which forces are driving cost in each category and responding accordingly.

According to Proxima’s Global Supply Chain Resilience Outlook, CEOs of the world’s largest companies are wary on many fronts. When asked which of five disrupting forces was the most worrying, their perspectives were almost evening split across geopolitical factors (22%), emerging technologies (21%), climate extremes (20%), increasing regulation (20%), and protectionism (19%). It’s a multi-threat environment.

Furthermore, while CEOs thought that they were in the main well prepared in the face of such threats, their operational runways were measured in weeks. When we asked them how long they could actually operate without disruption to revenue or customer delivery if a major shock hit tomorrow, just 13% could last beyond three months. More than half (51%) couldn’t last beyond three weeks.

Investments in Resilience

This may be why we’re seeing a rise in strategic inflation, as companies invest significantly in measures to cope with disruption. Indeed, almost three-quarters (72%) of CEOs say they would accept an uplift of more than 10% on their current third-party supplier costs to guarantee supply chain resilience. The mean is 17.3%. For a global business with a multi-billion-dollar cost base, this is one of the largest supply chain spending shifts on the C-suite agenda.

Of course, this isn’t a uniform 17.3% increase in all supply costs. Cost inflation isn’t equal, and neither is the primary method to fund it. CEOs reported that cost savings would be the primary method (38.4%), followed by pricing increases (35.3%) and reduced margins (26.3%).

What this means for procurement professionals is that they might be fighting different causes of inflation, with different suppliers or within different supply chains. There’s a clear expectation that procurement can be a key strategic enabler of resilience through both supply chain strategies and generating investment funds through savings. This puts procurement firmly on the strategic agenda. However, it also means that procurement teams need to be thinking about which business outcomes to drive with which supplier, in the face of which types of threats.

Not All Supplier Relationships Are Equal

The truth is that strategic relationships need to be handled with care and redesign with intent, but not every relationship is strategic. In fact few are. For every strategic partner there are likely hundred if not thousands of suppliers whereby procurement teams can push harder on cost. And, of course, there are multiple inflationary forces to consider. Not all suppliers are equal, and not all inflation has the same cause. The treatment depends on the diagnosis.

Procurement teams will need to assess when to protect, challenge, redesign or invest:

Inflation Type

Procurement Response

Defend the business

Behavioral

Separate fact from opportunism

Structural

Change the operating model

Save to invest

Buy deliberate resilience

Protecting means taking the immediate steps to mitigate cost and supply upsets. The current crisis in the Middle East, and in particular the disruption in the Strait of Hormuz, is a good example of this. Energy shocks have priced their way through the system in advance of supply shortages for things like fuels and chemicals, which will ripple through supply chains and global pricing frameworks. Teams might turn to hedging, inventory strategies, contract mechanisms and close market monitoring in order to absorb volatility while preserving a level of continuity.

Where inflation is deemed to be behavioral, procurement teams need to be in challenge mode. There’s a lot of opportunistic behavior in the market, whereby price increases aren’t backed up by data. Rising costs should always be challenged, using should-cost models or open conversations to understand justifications.

Structural inflation is altogether different. Traditionally, structural inflation like labor shortages, regulation, deglobalization or long-term geopolitical developments can be seen from far out. This type of change takes time to flow through the system, but can have long-term implications that are hard to influence. Procurement teams should work with their suppliers to innovate around the challenge, seeking to mitigate cost pressures structurally rather than tactically.

Strategic inflation is perhaps the newest and most interesting trend. Businesses are now choosing to invest in resilience in order to create strategic long-term supply assets. Procurement teams need to be in on the ground floor for these discussions with a lens on not accepting unnecessary cost, but ensuring that every dollar invested delivers measurable commercial and operational value. This will mean taking informed or deliberate decisions on both where resilience matters most and the strategies needed to achieve it, such as dual sourcing, diversification and right-shoring.

The exciting thing for procurement teams is that markets continue to move, and there’s significant opportunity to be had. Businesses are asking for a greater say in creating long-term commercial advantage. The teams that thrive will be those that understand what kind of inflation they’re facing, and choose the right response.

Edward Winterschladen is executive vice president, EMEA with Proxima.

Source: SupplyChainBrain