The Supply Chain Challenge
Businesses Bolster Inventories, Woo Suppliers to Keep Customers Happy
Abstract: The increasing demands of a rebounding economy and the breakdown in shipping patterns caused by the Russia-Ukraine war are further stressing supply chains long disrupted by the COVID-19 pandemic. Rising inflation is making matters worse, as companies place orders for more goods than usual to increase inventories before price hikes take effect. Dealing effectively with the resulting delivery delays requires better coordination with suppliers, locating of backup sources, bolstering of inventories, and boosting automation. Businesses must evaluate the risks attendant with an uncertain recovery path while dealing effectively with increases in the costs of raw materials, labor, and inventory.
Businesses are grappling with recurring supply chain issues in the wake of a rebounding American economy, shipping disruptions caused by the Russia-Ukraine war, and inflation. Faced with robust consumer and commercial demand, companies are beefing up costly inventories and wooing second-level suppliers to help close the gaps when shortages arise.
Product shortages and delays—and associated price hikes—have been no strangers to companies in recent years, thanks to international tariffs. What had been an exercise in efficient materials distribution, though, morphed into a full-scale crisis with the arrival of COVD-19 and its effect on labor shortages, bottlenecked ports, and shuttered production facilities. The return of a vigorous economy only increased pressure on an already thinly stretched delivery structure as businesses and consumers accelerated their purchasing. The arrival of inflation caused businesses to increase their buying of goods even more, in a move to beef up inventories before anticipated price hikes kicked in. Finally, in early 2022 the Russia-Ukraine war created shipping disruptions that fractured vital sections of the global supply chain.
All of these forces have come together to create a challenging environment for businesses looking to balance the dependable delivery of raw materials with the need to keep inventory at manageable levels. “Everyone in manufacturing and wholesale distribution seems to be dealing with supply chain disruptions,” says Bill Conerly, Principal of his own consulting firm in Lake Oswego, Oregon (conerlyconsulting.com). “Many companies are telling me the problem seems to be getting worse as pent-up demand creates additional pressures.”
Broad effects
The supply chain imbroglio has engaged a broad spectrum of industries. “For a number of years our member companies have been dealing with disruptions caused by factors such as tariffs and higher energy costs,” says Tom Palisin, Executive Director of The Manufacturers’ Association, a York, Pa.,-based regional employers’ group with more than 370 member companies (mascpa.org). With its diverse membership in food processing, defense, fabrication, and machinery building, Palisin’s association can be viewed as a proxy for American industry. “Companies in just about all sectors have experienced pauses and shutdowns. Some have even gone out of business.”
Labor shortages are one of the most persistent causes of distribution slowdowns. “One banker told me that his four manufacturing customers could each hire 50 additional workers if enough applicants were to show up,” says Conerly. “When a company I work with in Portland was awaiting a shipment of brass from Los Angeles, it turned out there was no driver for the truck.”
The reasons for labor shortages are varied. “Part of the problem is that people are not yet willing to come back to work,” says Conerly. “But the fact is that there were not as many pandemic-related layoffs in manufacturing as in, say, food service. A larger issue is demographics: Older people are retiring, and younger people don’t want to go into dirty, noisy factories. And then you have government cash payments for people who get laid off. And finally, there are childcare issues.”
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The labor shortage has caused an increase in automation as a way to produce goods with fewer man hours. “In recent months there’s been a surge of business orders for capital equipment,” says Conerly. “The fact that manufacturing production has not reached all-time highs, though, indicates that the new equipment is not intended to boost capacity. So I think a lot of the business capital spending is intended to replace empty positions with machines. The idea is ‘If I can’t hire somebody to assemble this product, maybe I can hire a robot to do it.’ And I think that’s a good strategy.”
A decline in the cost of automation has helped fuel this trend. “The cost of labor has gone up while the cost of electronic equipment has gone down,” says Conerly. “Something that did not pencil out a few years ago may well do so today.”
New strategies
Companies are responding to the supply chain challenges by doing more with less, running machinery beyond its prime, and collaborating with vendors to predict shipping delays. Such moves strike a familiar chord with Palisin at the manufacturer’s association. “The pandemic has really highlighted the need to develop strategies to mitigate potential disruptions in the flow of critical components,” says Palisin. “That means doing a deep dive into the supply chain, mapping the geographical locations of the first tier of suppliers and learning about the reliance of second tier as well.”
Pandemic-related shortages have affirmed the need for backup vendors even for lower volume items. “Instead of relying on one supplier, a company might have three to manage risks,” says Jim Hannan, Practice Leader of Manufacturing, Distribution and Logistics service group at consulting firm Withum (withum.com). “We expect this trend to continue with the advent of environmental, social governance (ESG) standards at larger companies.”
When deliveries are spotty, companies are tempted to keep more stock on hand. “Companies should no longer rely on just-in-time inventory strategies, which too often have become just-too-late failures, and stockpile more supplies both in the United States and abroad,” says John Manzella, a consultant on global business and economic trends, East Amherst, NY (JohnManzella.com). “This approach reduces efficiencies but favors risk reduction.”
Companies are willing to turn upside down the traditional views of inventory control, given the increased risk of shortages and customer goodwill. “Many companies are investing more cash in inventories, and banks seem content with lending against that,” says Hannan.
While businesses must pay the price for bolstering inventory levels, such costs must be balanced against operational expenses such as the need to pay higher prices for goods when a company scrambles to fill customer orders—or lost revenues when an unhappy customer jumps ship for a competitor. As they balance such costs, many companies are viewing higher cash flow on the shelf as acceptable. “Risk mitigation has become more important than efficiency gains,” says Manzella.
Furthermore, three historic costs of inventories–interest, obsolescence, and shrinkage—no longer universally apply. “The interest rate you get for having cash in the bank now is approximately diddly squat,” says Conerly. And obsolescence would only be an issue if something were expected to go out of fashion. “Many products in short supply today are the same products as last year’s model and they are not going to go obsolete.” Shrinkage, he adds, is not an issue in some industries and in others can be controlled with requisite security steps.
Cheap or not, inventory storage must be allocated selectively. “Companies need to be thinking, ‘what might be in short supply when we try to ramp up our production?’” says Conerly. “They may well buy a year’s supply of a relatively cheap item that is a small part of what a company uses but is vital to producing a finished product.”
Despite the inventory mind shift, business owners feel that a return to the days of warehouses bulging with expensive inventory is not in the cards. “Everybody has become accustomed to reducing costs by minimizing touch points, moving goods from the ship straight to the distribution facility and on to the customer,” says one operator. Indeed, cooperative efforts with suppliers and customers may well help bring back a greater emphasis on JIT. “I believe that the economy will eventually get back to that just-in-time concept as market disruptions lapse and the continued collaborative partnerships with vendors and suppliers remain a priority,” says Hannan.
The road ahead
Businesses face a conundrum as the world emerges from the pandemic: How quickly will demand increase for products and services, and will the increase be steady or erratic? The wrong answers can result in a pile-up of inventory or lost revenues and customers. “The risk is especially great for consumer and business goods requiring long lead times where businesses can’t easily turn the supply chain spigot on and off,” says Hannan.
The solution, says Hannan, is to develop a playbook to address possible disruptions and evaluate risks up and down the supply chain, then develop a plan to address those risks. And management must grapple with other unknowns such as whether the recent surge in the price of manufactured goods can be passed along to the consumer.
All this may soften profits until everything shakes out. “Revenues will probably hold up or even increase because of higher demand, but margins will likely be hit because of increases in the costs of raw materials, labor, and inventory,” says Palisin. “It’s a very unusual situation where all of these cost increases are happening at once—and at a time when tariffs are still in place. Companies just can’t pass along everything to customers.”
As for the road ahead, Conerly anticipates a gradual improvement in the operating environment. “Now that people are able to travel, they may well return to spending on vacations instead of home improvements as they did in 2020 when demand for household furnishings and building materials challenged the whole supply chain,” he says. “Consumers who have already completed their projects will be spending their money elsewhere.”
Indeed, many operators feel that with the pandemic coming to an end, now is the right time for businesses delivering quality service to gain market share. Says one: “We’re assuming the worst and hoping for the best. Our overriding goal is to protect the health of our people and service our customers. Those things haven’t changed a bit. And we’ll do what it takes to get it done.”
Phillip M. Perry is an award-winning business journalist based in New York City. He covers management, employment law, finance and marketing for scores of business magazines.
