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Category: Procurement and Sourcing

Supply Chain Inflation is Back – What to Do About It

 

AlixPartners Says CPOs Need a Proactive Strategy

 

July 12, 2018
SCDigest Editorial Staff

After a decade of mostly flat and often declining prices, inflation is coming back into the supply chain.

Supply Chain Digest Says...

The report concludes by noting that "The reality is, the calm seas we have enjoyed for the past decade are ending.

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Prices for commodities and components have indeed been stable or declining since the start of the Great Recession in 2008, which sent prices tumbling, but with the trend continuing even as recovery began.

That can be seen in the graphic below, which chart changes in the Bloomberg Commodity Index over the past decade.

The Index tracked an annualized return over the past 10 years of -8.4% for a broad basket of commodities.

 

Why such a benign commodity cost environment even in a recovery, albeit until recently a very modest one? A new report from consulting firm AlixPartners says it has been a combination of force. Those include globalization, technology advancements that have driven productivity, and new procurement tools that allow buyers to better leverage spend with vendors.

But the times they are a changing. AlixPartners notes that a variety "factors are shifting the balance of power back to the vendors, and the procurement team must be prepared."

Chief among those factors is much stronger economic growth both in the US and across the globe after years of lukewarm conditions since the recession.

The positive impact of globalization in keeping prices low may also be waning. Wages are rising rapidly in many low cost countries, noticeably China.

As evidence of the changing environment, the Prices Index from the Institute for Supply Management came in at a level of 76.8 in June, far above the 50 mark that indicates about half of the businesses in the monthly survey are seeing higher prices and half are not, and indicating higher raw materials prices for the 28th consecutive month.

Those existing upward price pressures are likely to be accelerating in coming months, the result of tariffs the US is placing on a variety of imported goods.

One early example can be seen with aluminum, which reached a six-year high on the London Metals Exchange in April 2018, up 20% from the announcement of US sanctions on March 1.

So what should procurement executives do in the fact of this new cost landscape? AlixPartners offers some suggestions:

Step 1: Reef the sails:

• Actively communicate with key executives and business owners about potential cost increases that may be coming. Discuss the overall environment and factors which may be driving up costs in the future. A clear and ongoing communication strategy will ensure management is not surprised down the line and allow for more effective risk management. (SCDigest will comment that clearly most executives know things are changing – what they need to better understand is by just how much.)

• With the business owners, consider ways to reduce costs by improving production methodology or by lowering product specifications. Explore strategies, such as cost workshops, zero-based budgeting, and the appointment of a spend czar, to temper demand and consumption of goods and services.

• Engage with the finance team to explore potential hedging techniques through either financial instruments or via customer contracts.

• Work with the warehouse team to employ dynamic inventory management: increase inventory levels for goods as price trends increase, and decrease inventory levels as price trends decrease.

• Proactively reach out to key suppliers to start reinforcing and enhancing the relationships to start the battle for the hearts of suppliers. This is also an ideal time to begin exploring new vendor relationships to find new lower-cost suppliers.

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Step 2: Batten down the hatches:

• Begin entering into longer-term contracts with fixed pricing. We have seen vendors reduce prices by 2 to 6% by extending contracts by two to three years.

• Increase two-way communication with suppliers. Explore ways the company can modify its business practices to make things more efficient for the vendor and then share in the cost decrease.

• Institute a price increase approval process with vendors to delay the actual price increase for as long as possible. This process would include written justification, duration of increase, and key performance indicators for price reduction.

Step 3: Run downwind:

• Aggressively trim smaller vendors to consolidate the supplier base by each category in order to increase negotiating leverage and press for lower rates.

• Institute a "champion/challenger" model for all key categories with 70 to 80% of the business going to the champion and the remainder going to a single challenger. This will keep both parties hungry. The champion and challenger should also be rotated periodically, though not too often as business disruption is also costly.

• Search for new suppliers and give new suppliers a chance to prove themselves if the pricing is better than the incumbent. Potentially try a new vendor as the challenger (or as a second challenger) to balance disruption with cost savings.

• Execute a cost-to-price initiative. Assemble a cross functional team to help quickly understand the direct relationship between input-cost inflation and necessary customer price increases to maintain or improve product margins. For global companies, this should be done on a country-by-country basis with key performance indicator heat maps to ensure proper indexing of price inflation.

• Hold a supplier conference in which the suppliers are given indicative cost reduction targets and asked to come and present to the company their ideas. This demonstrates a commitment to the relationship and working together to solve pricing concerns.

The report concludes by noting that "The reality is, the calm seas we have enjoyed for the past decade are ending. However, with communication and a proactive and coordinated strategy, the CPO can prepare for the coming instability."


What would you add to this advice from AlixPartners on what to do about rising prices? Let us know your thoughts at the Feedback section below.

 

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