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First Thoughts
  By Dan Gilmore - Editor-in-Chief  
     
   
  September 18, 2008  
     
 

Supply Chain, AIG, and What's Next

 
 

Well, this has certainly been an interesting week.

Like most of us around the globe, I’m not sure exactly what’s happening as financial markets meltdown from Moscow to Wall Street. Add to that a hurricane, a crazy election cycle, and all the other tumult we’ve already been dealing with, and it’s easy to get a little dizzy.

Gilmore Says:
Credit is tight. That puts an extra premium on managing inventories to reduce working capital requirements – meaning less credit is required to fund operations.

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As usual, it made me take a step back and try to make some sense of it all. This may veer at times into some areas only on the periphery of supply chain directly, but we all understand SCM operates in the context of business and even the political environment, so I hope it’s all relevant.

First, the current financial crisis – and expectations for slowing oil demand not only in the US and Europe but also China and India – has led to a precipitous drop in oil prices, from almost $150 per barrel just a short while ago to the low $90s briefly this week. It’s now back up to about $100, but is not expected to rise much in the short term, and will likely fall again.

But just for some perspective, I took a look at oil prices at this time last year: it was about $83 per barrel in mid-September 2007. So, oil is still up substantially year on year, and when it reached the $100 per barrel level in 2007, which now somehow seems like a relief, there was widespread dismay, and rightfully so. Logistics is still very expensive at that level.

We also haven’t solved the basic issue, which is demand that just about matches global output. So, while we can expect some modest relief from the worst we had of it for awhile, I can’t look at the mid-term with much confidence. Demand will rise again, and probably soon, and any disruption continues to drive prices higher.

So, I think we will see the same pattern that we have for the past few years – that price increases followed by drops in oil prices simply lead to higher lows. The curve overall continues to ratchet up. If we “settle” at $90 or something, you can expect $120 or more sometime in 2009.

The same is basically true for many commodity prices. The sharp drops we’ve seen are still to levels well above where we were a few years ago, and the basic dynamics haven’t changed.

As the government bails out insurance giant AIG, there are growing calls by the US automotive industry for a similar program to get them temporarily out of their current misery. The latest I’ve seen is for a low-interest $50 billion government loan for revamping plants, car designs, and green technology development.

They’re smart, recognizing in an election year and with lifelines going to Wall Street firms, it will be hard for politicians of any stripe to let the auto industry fail. What may ultimately happen, though, is that the crushing, direct health care costs that are a real burden both to Detroit and other US manufacturers vis-à-vis global competition may reach a “tipping point” that forces action of some kind.

At the same time, we have an election with two very different views on key issues for the supply chain. The Democrats are pushing legislation that could make it much easier for unionization efforts, which is a genie in a bottle that no one is quite sure what will happen if it is unleashed. It is also likely they would push for greater trade barriers and some level of protectionism – the real question is how much, how fast.

That isn’t meant as a political statement – it simply says that if one side wins, we are likely to see more action that changes the global trade and sourcing environment we operate in now than the other – and everyone needs to understand what that might mean to their companies and industries.

All of which is to say, as I have in the past, that we are in an era of simply unprecedented supply chain dynamics. Will oil plummet back to $60, or soon return to a march back to $200? Is your non-union plant suddenly going to organize with a new “card check” law in early 2009?  Will burdensome tariffs be placed on imports from products you are just now deciding to source from China? Will the global economy and new areas of emerging demand get back on track, or will we all retrench to our own geographies for awhile?

If anyone knows the answer to these or other questions, please let us all know.

One more thing. As recently as just last year, a lot of supply chain conversation was around “what to do when your company gets bought by a private equity firm.” Dozens of companies followed that path over the last few years. There’s not much worry about that right now though. The PE’s can’t borrow the money to finance the deals, and many are trying to bail on deals they already signed. Save those presentations on what to do for 2012 or so.

So, it says more than ever that there is a premium on supply chain flexibility, both from a strategy perspective and from a more tactical execution level. How can your company increase agility?

It also says to me that you need to double down your efforts to improve supply chain visibility and “supply chain intelligence” efforts to reduce the latency between when you could know something important and when you actually do.

It is becoming simply essential to me to have network planning type tools available on a near continuous basis to help understand the impact that these supply chain dynamics have on optimal decisions, at multiple levels, and to perform scenario and sensitivity analysis that contemplates multiple potential conditions. You have to make a call, but want to keep the maximum options open if you can.

Credit is tight. That puts an extra premium on managing inventories to reduce working capital requirements – meaning less credit is required to fund operations. Have a conversation with your CFO or controller about what the supply chain could do here. You will probably find a receptive audience.

In general, I am a “cup half-full” person, and think things will actually bottom out here relatively soon. We actually have been in this for awhile now. To that end, I will also note that really smart companies use these kinds of times to innovate while others stand still, and to snatch market share where they can leverage competitive advantage. Use the supply chain to find ways to improve the bottom line of your customers.

Finally, I will say I think the US economy for awhile has been too driven by the financial industry. Those days are obviously gone for many years to come. Whatever form it takes, the “real product” economy is going to have a bigger impact on our economic growth than it has the past few years – and that’s good for the supply chain.

What are you comments on Gilmore’s thoughts on the current dynamics and what it might mean for the supply chain? Can these kinds of times sometimes be used to gain market share and competitive advantage? Is there a premium on supply chain flexibility now? And how do you increase agility? Let us know your thoughts at the Feedback button below.

 
 
     
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Feedback
2008-09-19

Sept. 19, 2008

The 'less credit' available to fund operations issue you raised really caused me to think about some recent industry reports and the focus of your point, inventory management as a cost of capital.

Here is my take:

Point One: The 18th Annual State of Logistics Report (2007 by Rosalyn A. Wilson) stated in the summary that "Inventory growth and higher inventory rates pushed inventory carrying costs to a record level, jumping to 13.5% in 2006."

The attributed causes were tied to global supply chain (our ever growing imports), higher cost of money, and more demanding service rates at retail (actually increasing to some degree the number of DCs and associated inventory).

Point Two: This greater number of DCs to support service metrics and greater demands in order fulfillment was noted in the 2007 Food Logistics Industry Report by Saddle Creek Corporation as well as the 2006 Aberdeen Group The Warehouse Productivity Benchmark Report.

 Point Three: WERC DC Measures in 2006 showed an increase in the 'days on hand' Financial Metrics rising from 16 days in 2005 to 17 in 2006. However in 2008's report, the reporting definitions changed making a direct comparison a bit more difficult but, median in 2006 was 35 days on hand and in 2008, median had dropped to 28 days.

Source data variability aside, it seems that inventory might be going down but that may also be the impact of more warehouses and distribution models working in the overall data (3PL versus direct).

My takeaway is that the world wide supply chain and tougher service KPIs (key performance indicators), along with higher wheels down costs (logistics) will make inventories more unwieldy and larger. If more manufacturing returns to the USA under the current oil scenario and the related increased cost of shipping goods in from emerging manufacturing nations, then inventories may go down due to local availability, but that seems unlikely.

If the current supply chains and world wide suppliers really tighten up their performance, that too could let down inventories, but I for one will not hold my breath on credit driving down inventories, but....

My take, for what it is worth.

Len DeWeerdt
LW Consulting,
LLC



2008-09-19

Sept 19, 2008

I liked your thoughts about the current crises. I also hope for the day when we become (again) a product-driven producer-society, and not that of 'financial products.'

Thanks.

Chris Alder
Analyst, Strategic Sourcing
Access Business Group



2008-09-19

Sept. 19, 2008

I, too, would like to believe Dan Gilmore's assertion that the influence of 'real product' will be stronger for the foreseeable future.

The financial industry should serve as the economy's electric grid, providing the power to drive factories. For the last 8-10 years, however, the financial industry has acted more like factories, creating incredible wealth for a few while the 'real product' factories are forced to make short term sacrifices to keep up or be bought up.

Unfortunately, when the power lines go down, everyone suffers. With its stronger influence, 'real product' industries are in the position to check and balance the power supply.

'Real products' are powered by lots of smart, hardworking people who should be confidently able to put their earned wealth in a safe, reliable financial industry. 'Real product' industries should not be afraid to shake hands with people and worry about being electrocuted.

Jerry Saltzman
Wyeth


 


2008-09-19

Sept, 19, 2008

Some thoughts based on conversations with industry professionals and points of view in excellent articles such as yours:

1. When designing global (even domestic) supply chains, the cost of oil fluctuating within an band should be a given. Determining the band requires the vision of oil economists.

2. Supply Chain implementation should remain as flexible as practical and be supported by planning tools that measure (on demand- weekly, monthly, daily) to the supply chain's performance against the established metrics.

3. Sourcing decisions should include a measure of tolerance for the price of energy within the selected band. Primarily because, finding capable labor, facilities and equipment takes time. Stated differently, planning ahead and accepting a short-term loss could be more than off-set by stronger mid- to longer-term gains in landed cost.

I enjoy your articles.

John C. Rader
Director Industry & Educational Services SMC³
SMC³



2008-09-18

September 18, 2008

Congrats, this is the best and most thought provoking supply chain article I have read all year.

John Fontanella
AMR Research


 




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