I had the pleasure in the last couple of weeks of speaking in detail with two of the industry’s real experts on supply chain network design: Jeff Karrenbauer, of Insight, and Mike Kilgore, of ChainAlytics, both heads of their respective companies.

The trigger was my commentary three weeks ago on “SCM and the End of Oil,” where I cited some extreme but increasingly accepted projections that oil prices, and therefore transportation costs, will rise at huge rates over the next few years as demand well outstrips supply.

According to both Karrenbauer and Kilgore, this really does change how you have to think about supply chain network design, in some cases accentuating principles they have long been espousing, in some cases adding some new wrinkles.

One impact is that many companies will need to redo or at least tweak their networks designs more often, Kilgore says. “An increasing number of companies are recognizing the need to replan their networks more frequently, and adjust the strategy on at least an annual basis,” Kilgore said. “The network is very sensitive to changes in business strategy and the operating environment,” he added. “When you combine the constant changes in business strategy with all the uncertainties in the supply chain right now, including the cost and dynamics of transportation, very few networks are good for more than about 12 months.”

Network strategy consultants have for many years complained that too many companies go through the hard work of a network strategy optimization and change, and then don’t think about it again for 3-5 years, until something happens, like a acquisition, or “the pain gets too great.” Is that a luxury very few companies can now afford?

When doing network analysis, the current environment changes the way you have to look at the options, both Kilgore and Karrenbauer agreed. This ultimately bleeds into several other areas, such as supply chain risk reduction strategies, of which oil and transportation cost volatility is really a part.

“You always forecast demand, but now you’ll have to forecast costs in much the same way,” Karenbauer said. “What could look good in the short term could turn out to be really bad under a different set of cost assumptions. In the past, you could use a fairly static level of costs in the model, but now that’s very dangerous. You need to evaluate a number of cost scenarios over multiple periods. That’s not often done.”

I wish we had room for all the insight both gentlemen provided us, but below are a few of the best observations and recommendations:

• More and more companies may move to hedging transportation costs through the proxy of hedging oil prices. ChainAlytics is actually working with a commodities trading firm to pilot a related service offering. Why? That way, you could lock in a known cost of transportation, and know for a period of time (say a year) that your network assumptions and hence the network itself would be good.
• You may have to fire some customers, or at least raise their prices to maintain margins. “If transportation costs continue to go up and you can’t pass those costs along fully, those customers may have to be pared, or you have to offer a different level of service,” Karrenbauer said.
• Postponement strategies are likely to continue to gain momentum. Kilgore notes that if you can reduce the number of manufacturing SKUs that need to be forecast, produced, and replenished to stocking points, it can significantly reduce the cost of transportation, in addition to other benefits. How? As demand and supply variability decrease with fewer SKUs to manage at the back end, companies may be more comfortable using slower, less certain, but less expensive transportation modes such as rail and intermodal to move goods to the network.
• Private fleets may be under pressure: “Companies are frankly often less than honest about the real cost of private fleets,” Karrenbauer said. “At low operating costs, you can maybe absorb that, but not if oil prices go through the roof.”
• The trade-offs between inventory and transportation will of course continue to migrate. Until recently, with low transportation costs, the focus was more on inventory reduction. Now, companies will have to rethink that equation, or plan for how to adjust that balance if transport costs continue to soar. “We see a lot more companies today be willing to hold an order to wait to build a better load,” said Kilgore.

That’s all we have room for. At the end of the day, what it says to me is that flexibility – the agile supply chain - is simply more necessary than ever. Let’s all hope we’ll never see $100-$200 a barrel oil, but you sure better have a plan if we do. SCDigest is working with Kilgore on a list of ideas for building flexible networks, which we’ll publish next week.

What do you think of Karrenbauer and Kilgore’s recommendations? Does transportation cost volatility and other factors mean we have to re-optimize our networks much more frequently? How flexible do we need to be? Let us know your thoughts.

Let us know your thoughts.

Keywords: supply chain network design, supply chain strategy, supply chain costs, logistics costs, agile supply chain, postponement, transportation