Inflation is rising and commodity prices are rocketing. Are we facing a new set of supply chain risks and challenges that may be far more long-lasting and structural than the economic set-backs of the last few years or the dramatic impact of the Japan earthquake? By Nick Allen.
Three years ago the global economy was about to plunge into financial catastrophe; banks were to fail, lines of credit were to dry-up and supply chains were to come under tremendous strain as the risk from suppliers going to the wall, or being unable to supply through lack of credit, played on the corporate consciousness.
Several years on, are we out of the danger zone? Have we learnt from our experiences? Can we protect our supply chains from danger? Or do we just face a different set of circumstances that present new challenges? The earthquake in Japan clearly illustrated the huge disruptive effect a natural disaster can have on automotive and electronics supply chains, but more insidious influencing factors such as rising inflation and rocketing commodity prices may present a more long-lasting catalyst for structural change.
With Britain close to recession, and yet other parts of the world, including parts of the developed world, growing relatively quickly, what are the implications for corporate supply chains? Colin Maund, chief executive of Achilles, a company that manages supplier information, says: “You have now got a situation where commodity prices are rising quite quickly because of increased demand in emerging economies, yet in the UK we are facing the problems of the end of a recession usually a time when you do not expect to see demand driven inflation,” he says. “We’re up against the problem of externally imported inflation at the same time as low local demand, which is causing a double squeeze. Supply costs are rising especially for those importing from emerging markets and those whose purchases are weighted by commodities such as copper or agricultural products yet at the same time companies are having problems passing those costs on to the consumer because the market isn’t buoyant enough.”
Maund emphasises that the squeeze is going to impact on how companies manage supply chain costs. “We’ve had the lunch and now we’ve been handed the bill,” he says. “For many years we have had massive growth in Western economies driven by a sudden reduction in costs brought about through outsourcing a large chunk of our manufacturing to countries like China. Now these countries are facing their own inflation domestically and due to commodities those costs are now being passed back and there is nowhere left to turn. The point is we have outsourced into an environment that is facing a different economic cycle from the one we live in.”
Maund believes that buyers will be forced into looking more strategically at their sourcing decisions no longer just taking tactical decisions to off-shore. “Events such as the Japan earthquake and the recent rise in commodity prices will force buyers to look at alternative sources and substitute materials, perhaps new countries coming in as sourcing centres, like Latin America or places like Vietnam,” he says. “This will place great pressure on procurement departments they will be struggling to deliver the savings most have become accustomed to.”
As commodity prices rise, it is likely that closer attention will be given to recycling especially where rare materials are concerned. The US is just bringing in the Dodds-Frank Act which deals with, among other things, the purchase of conflict minerals minerals mined in conditions of armed conflict and human rights abuses. “The Dodds-Frank Act is adding a great deal of regulation around the sourcing of conflict minerals and companies will have to show that they have product traceability in place to prove that minerals used haven’t come from a conflict area,” says Maund. “This will impact the cost of minerals as dubious sources are restricted and only sources that you know can be used. And this may make recycled materials more affordable.”
What can procurement directors do under these rather tough conditions of rising prices? One thing is, they need to have improved intelligence on their categories of spend where those categories are they need to have more information and more forward looking data on what’s likely to happen to commodity prices. Access to financial data on suppliers is important too. With rising levels of supply chain risk Maund believes it may be that supply chain insurance starts rising up the agenda. “It’s a relatively new area that insures companies against disruption in their supply chain. It may be expensive but if you are shutting your car plant for several weeks, that’s pretty expensive too. The important question is How real do you think the risk is?”
Brian Sullivan, logistics insurance director at TT Club, supplier of insurance to the logistics and transport sector, says: “If you are going to insure a supply chain you will need quite a lot of information if you are going to cover that risk and I’m not sure customers have typically got that visibility on their supply chain,” he says. “They may have it at first-tier supplier level, but once you get beyond that, to suppliers of suppliers, visibility is low. If you’re an insurance company and you don’t know what your exposure is then you can’t really insure increasingly insurers are not prepared to provide significant limits on an undeclared basis.”
Sullivan says that it would be necessary to invest time and effort in providing full risk information to a potential insurer. “If you want to insure your potential loss of revenue or interruption to supply for millions of dollars you are going to have to say who is supplying you, where it is coming from, where their factories are, whether or not they are in a quake or storm zone, the sort of protective measures that are in place and how robust they are,” he says. The TT Club does not presently offer a policy that provides “all risks” business interruption cover. However, Sullivan says: “In the automotive sector you often see manufacturers outsourcing the responsibility for the just-in-time supply of components to the line. We see contract obligations being placed on logistics companies for JIT deliveries and penalties if they can’t deliver we do take on some obligations for that.”
The fire at an oil storage depot in Buncefield, Hertfordshire, in 2005 impacted a number of distribution businesses in the area. Affected companies were unable to access the area and move inventory for their customers. “I know that certain businesses went out of business at that time because their contingency plans weren’t good enough and unfortunately, big blue chip companies aren’t prepared to wait while you sort out these problems,” says Sullivan.
Zurich introduced “all risks” business interruption cover for supply chains two years ago. Nick Wildgoose, global product manager, supply chain at Zurich says: “Most insurance companies offer cover for physical damage to a supplier’s premises, but to trigger the policy you have to have physical damage specifically to the supplier’s premises.” He points out: “In the Chile earthquake there was a situation where the supplier’s factory was not damaged in any way but two bridges the only way from the factory were taken down, so the customer was stuck and they couldn’t make any insurance claim because the damage wasn’t to those premises,” he says.
Wildgoose highlights the fact that this may well be the case in Japan too, where factories may still be standing but port facilities have been severely damaged. “What our policy does is take it beyond physical damage, to insolvency, strikes and all these other impacts that may prevent a supply chain from operating successfully.”
Principle “exclusions” are around quality. “If the goods can still be provided to you as a customer, but they are not in accordance to spec. on the contract that is an ongoing commercial discussion between you and the supplier,” he says. “We’re there to handle the things that are beyond your control. The other exclusions are the more standard insurance exclusions, such as war. Other than that we have made the policy quite comprehensive.”
Wildgoose says: “The Japan earthquake has certainly boosted interest in the topic of supply chain risk and there is a lack of awareness around this policy in the market place. The risk area is something that needs to be managed properly, insurance is only one tool in the tool kit bag, but it’s useful that companies know it’s available.”
“We look at named supplies and suppliers the critical ones,” he says. “I don’t underestimate the challenge in certain complex goods, there are lots of key suppliers when you take a car or something like that, but that’s the first thing to know, who your key suppliers are, and then we can run the risk assessment process that looks to understand that supply chain right back to the raw materials level. That’s what we are trying to do with the client, as that’s the level of understanding they should have. Then we calculate the risk and premium to charge based on that analysis.”
Removing waste and cost is critical to improving the financial performance of a supply chain. Jerry Shanahan, partner at Oliver Wight says that benchmarking your supply chain performance can improve service and reduce supply chain costs by as much as 50 per cent. “Benchmarking your supply chain performance will allow you to identify performance gaps and provide a financial evaluation of the gains that can be made off the back of performance improvement,” he says. “Typically you can expect the potential savings to be at least ten times the cost of benchmarking.” Oliver Wight has an online supply chain benchmarking tool, which is used globally, by all sizes of organisations in all industry sectors.