How to Mitigate Rising Supply Chain Costs
Every distributor knows that the supply chain has broken down and costs are out-of-control, but what can you do to mitigate rising supply chain costs ? In this blog, we trace some of the causes of supply chain inflation and suggest strategies to mitigate rising supply chain costs.
Causes of the Supply Chain Crisis
The current supply chain crisis is a direct result of how global and how interconnected supply chains have become over the last few years. As with any interconnected system, problems in one area of the system quickly metastasize into problems in other areas. The reliance on manufacturing from one region, Asia, has made the impact of supply chain shocks all the more serious. Faced with a global pandemic of uncertain lethality but very high transmissibility, many countries instituted lockdowns which shut economies down and created widespread economic disruption. Combined with other geopolitical shocks the situation quickly devolved into the hopelessly backlogged supply chain crisis we are now experiencing.
Supply Chain Inflation
The Coronavirus pandemic and the unprecedented lockdowns and massive government spending that followed, together created a global inflationary environment. These global inflationary trends were further exacerbated by labor shortages and energy market disruptions, including most recently the Russia/Ukraine conflict. Against this inflationary backdrop, the current supply chain crisis in which goods are not moving has led to shortages, backlogs, and rapidly rising supply chain costs – often referred to as supply chain inflation.
Effects on Supply Chain Costs
We have seen massive increases in the container freight index as an indicator of overall freight costs. The index is now almost ten times the level it was 2 years ago. The energy cost increases, pandemic travel restrictions, lockdowns and social-distancing of employees, labor shortages of longshoremen and truckers created by public-health mandates, have all played a part. Together all these factors have combined to create breakdowns and bottlenecks in the global supply chain. These bottlenecks have caused shortages in goods that have created rising costs across the entire supply chain. The biggest issue facing distributors across the board is how best to implement strategies to mitigate rising supply chain costs.
Raising Prices to Offset Supply Chain Costs
Can distributors pass on higher supply chain costs? The answer is a definite maybe. Some industries can pass along higher input and distribution costs to customers, but some, like the cruise ship industry, for example, cannot. In general, though, passing on increased costs is something that should be done hesitantly as it creates the risk of losing customers that are already struggling economically themselves. However, we are now facing extremely challenging conditions. Inflation is at a 40+ year high and a recent Federal Reserve survey found that 90% of respondents were facing supply chain constraints that were driving extraordinary cost increases. Most of these respondents saw no signs of slowing in the near term at least through the end of the year. According to the Fed, about 80% of these companies are passing some portion of their rising costs on to consumers. Of the companies passing along rising costs, many are also absorbing some portion of the increased costs which will reduce their margins and affect their growth. The Fed survey found that 55% reported lost sales amounting to 5% - 7% of 2021 sales. If you are a distributor passing along rising costs, you need to determine what portion of these costs your customers can bear without seriously affecting sales. Make sure you document and explain to customers why you have been forced to increase prices.
Other Initiatives to Mitigate Rising Supply Chain Costs
If you can pass along some portion of your rising costs without too many negative consequences this is the first step to take. In addition to passing along costs, distributors can and should take several other steps to mitigate rising supply chain costs.
Invest in technology and automation
No one could have predicted how quickly the supply chain crisis would unfold in the face of external shocks and bad public policy decisions. However, having the technology and business intelligence capabilities to have full visibility into all aspects of your supply chain, to run “what-if” scenarios, to spot early warning signs, and take remedial actions quickly, is profoundly important. It could mean the difference between your company’s survival or failure in these very turbulent economic conditions. Automation is something that should be continually pursued. Incurring rising costs but not being able to automatically increase prices, for example, can quickly lead to problems. Moving to batched warehouse processes and handheld scanning are huge productivity enhancers and are a critical part of responding to labor shortages. Similarly, being able to access multiple national carriers and regional networks can help address shipping and transportation issues.
Restructure your supply chain
All companies should take steps to restructure their supply chains. The current crisis has served to highlight the fragility of the global interconnected supply chain. It works well until it doesn’t and then, given the concentration of manufacturing in China, geopolitical and other external factors can quickly break it. Companies adversely affected by global supply chains issues should diversify suppliers and try to move as much of their supply chains as possible back to the US. These initiatives may not yield results in the short-term but taking steps to diversify and reduce risk and reliance on one region will better position you in the future to respond to continuing and new supply chain shocks.
Reconfigure your purchasing spend
As a short-term measure to mitigate rising supply chain costs, you can move all your purchasing to inflation-indexed contracts. You can also ask suppliers for adjustments to unindexed contracts as a condition of future business. Most of your suppliers are in similar predicaments to yours, and you should explore collaborative approaches with your suppliers.
Identify your strategic customers
Analyze your customer base to determine which customers are truly strategic for you. Invest in those strategic relationships over and above those relationships that are largely transactional. Make sure your strategic customers understand what they mean to you and that you are doing everything you can to support them in a time of extreme economic disruption. Explore opportunities to provide some degree of supply protection and priority to strategic customers in exchange for guaranteed demand.
Cut costs in your supply chain
There are several steps that can be taken to cut down on costs. Many of the largest and most labor-intensive costs are in Inventory management, product analysis, purchasing, and warehouse operations. These are all big cost areas that can make a big difference to your supply chain costs.
Inefficient inventory replenishment decisions, overstocking/understocking inventory, misplaced and/or damaged goods, are among the highest contributors to distributors’ costs. If you seek to cut your supply chain costs, you will have to optimize your inventory management.
Implement business intelligence capabilities to analyze which products are delivering the most to your bottom line. To do this you have to consider multiple factors including how quickly products move, what investment is tied up in them, what margins they deliver, how critical they are to your customers, etc. Optimizing the lines of products that you carry can have a big impact on costs.
Streamline your purchasing and consider using multiple qualified suppliers every time to get the best prices. This will also allow you to respond quickly to supplier problems. Consider implementing RFQ (request for quotation) functionality that will allow you to send every PO to a wide list of suppliers.
You also need to optimize warehouse operations that are typically laborintensive and error prone. Focus on getting the right warehouse management tools and consider whether outsourcing warehouse operations to a 3PL might make sense.
Make sure you are rate shopping against all major national and regional carriers to get the best rates. Employ advanced shipping analytics to compare costs of expedited shipping against statistically significant expected delivery times to find savings.
To get through the current supply chain crisis, which is leading to rapidly increasing costs, you have to be prepared to rethink your business. Determine which costs can be passed on to your customers but be aware that raising prices could cause you to lose some customers which could affect your growth. On the other hand, absorbing some of the increasing costs will reduce your margins and impact your ability to invest in optimizing your business. You should consider this question of how much to raise prices very carefully. You should also, take active steps to restructure your business to make it more responsive to supply chain effects and to reduce costs. ADS Solutions’ Accolent ERP is Cloud-based software that can help distributors respond to the current supply chain crisis. Contact us to learn more about what you can do to try to mitigate rising supply chain costs.