Words: Thomas Karger and David Seewald
The appetite for a reliable supply chain has never been stronger across the C-Suite. We can help you to start the conversation.
The worldwide outbreak of COVID-19 hit many companies by surprise. With suppliers shutting down production in Asia first, procurement and supply chain executives were immediately confronted with the vulnerability of their global supply chains. In fact, 94% of the Fortune 1000 companies experienced supply chain disruptions due to COVID-19, as per a Fortune report. Not only were raw materials affected, but also low value items critical for production. With businesses all seeking available alternatives at the same time, supply markets experienced a turmoil that we have not seen in past decades.
The scientific community agrees that major outbreaks of communicable diseases, like COVID-19 will be highly likely in the future, according to the World Health Organisation (WHO). Furthermore, we are also likely to experience additional disruptions to supply chains that result from climate change and political instability.
We need to immediately structure and apply the lessons learnt for our supply chain setup. With top executives now being aware of the inherent risks in their supply chain, our key takeaways and recommendations will help you guide leadership into committing to a newly structured, more reliable supply chain setup. Efficio will publish a series of articles to elaborate on the key learnings and recommendations for procurement and supply chain executives.
Supply base resilience
COVID-19 has exposed weaknesses in global players. While the ever-evolving trend in procurement over the last two decades to source key-components and raw materials from low cost countries like China has yielded savings for procurement departments, it has now exposed over-reliability on suppliers from these geographic regions. Companies must analyze the global footprint of their supply base to avoid supply-side risk from one geography. The crisis has shown that companies that have developed and implemented supply chain risk management as part of their SRM framework are prepared better to mitigate the business impact.
It is key to implement these risk assessments into your supplier relationship management (SRM) strategy and develop business continuity plans. They should not only cover ongoing review of your global supply-base setup in terms of geography but also economic and political risk analysis of the countries in which your suppliers are located. You should additionally review the setup of your suppliers; i.e. how many intermediaries does your supply chain contain and how far away are suppliers located? In essence, all of these topics impact your supply chain complexity.
Companies should multi-source strategic commodities or key components to reduce their dependence on one supplier. This recommendation held true before the impact of the pandemic and has been strengthened by it. Supply chain and procurement executives need to analyze their spend and reduce reliability on one supplier and one geography.
The decision to develop a second source is likely to have a commercial impact, especially on volume rebates and tiered pricing mechanism with existing suppliers. It will also add complexity to your supply chain in the short run; but it is key to business continuity and, in most cases, worth the risk premium you will be paying as a firm.
We understand that this is a multifactorial decision that depends on the technical complexity of the category and thus qualification requirements. In cases where second source is not an option on the table, your incumbent supplier should provide you with multiple production facilities spread across different geographies to mitigate logistical risks such as border closures.
A new approach to inventory management
Inventory and stock level management proved to be an ongoing discussion between procurement and production. While working capital optimization is generally directed by the C-Suite across all procured goods, the operations department usually hesitates to reduce stock levels to the minimum, fearing disruptions in the supply chain. As a lesson learnt for the recent COVID-19 outbreak, we need to apply a new approach to the topic.
Procurement and supply chain executives need to closely review their material and develop much more distinguished strategies for each sub-group of materials. Many companies suffered severely from the lack of supply of low-value critical items, like the recently very expensive PPE equipment, such as mouth and nose masks. Companies need to include such low value items into their thinking as “strategic goods”, as we cannot produce without them. Moving away from working capital optimization for such low value items will have only very limited impact on the cash levels but significantly improve supply reliability.
Another hot topic in this area is just-in-time delivery. Over many years, this has been the focus for supply chain managers. With the recent disruptions in supply, as well as rising political uncertainty, an adjustment to today’s reality can be required to increase reliability. Not all goods should be stocked, but taking out several low value, long-lasting items can improve your supply chain reliability and even reduce complexity within your organization.
It’s time to re-evaluate contract structures
None of us expected such a disruption before 2020. Many contracts have included some sort of force majeure for both parties to retract. However, in most cases on a more practical consideration, we do not want to retract or stop the contract. We will continue working with the same suppliers before, during and after such a disruption. Only the commitments and requirements to the contract will change; the contract itself is not up for debate.
There are a handful of key commitments that you should require from your suppliers during such a disruption, and we need to update our contractual framework for such events. Executives should ask themselves a set of questions and ensure to cover them exhaustively in their contracts:
- How are we dealing with short-term changes (e.g. production stops)?
- How can we ensure supply safety and supply priority?
- What if prices are changing rapidly (like face masks)?
- What happens if volumes are committed?
- How are business risks shared?
Also keep in mind that you are dependent on some smaller, more fragile suppliers. In this case, you need to ensure reasonable payment terms can be applied during a crisis. You can quickly harvest the benefits from stabilizing your supply chain by keeping smaller suppliers alive.
Don’t forget to include your customer contracts in this review; they are equally important for you to understand your contractual commitments in times of disruption. There is no one-size-fits-all answer to these key questions. A joint approach with your key suppliers will help you to establish a more reliable supply chain and improve your strategic partnerships.
Treat your logistics providers as partners
Another important take-away from the current crisis, especially after border closures outside of China became reality in Europe, is to evaluate your logistic setup. A significant reduction in global air traffic also led to a decrease in air freight capacity upon (while prices significantly increased) which many global players rely on for their just-in-time delivery models. This led to delays in production due to missing critical items but, more importantly, to increased congestion at major ports across the globe.
On the road, especially transcontinental road freight suffered from truck driver shortages, who were afraid to drive to epicenters of infected areas. Those who took the risk, charged a significant premium that ate into narrow margins in some industries. Border crossing times have gone up leading to increased lead times as well.
Companies need to treat their logistics providers as partners to secure capacity and evaluate different routes to get the products to their customers. During the restart it is expected that there will be a spike in logistics requirement resulting in a strain on logistics capacity. Businesses need to act now to secure capacity.
Sourcing and ’make vs. buy' decisions
Many organizations have disinvested parts of their manufacturing and production capabilities over the past years. It was mostly labelled as ‘focus on core activities’ to create cash (carve-outs) or due to market pressure (more competitive suppliers). With the created vulnerability being clear to executives, some decisions might be re-evaluated.
As a procurement and supply chain executive, your role is to support this decision-making by:
- Assessing the market risk for each commodity
- Providing transparent pricing (internal and external) to the decision makers
- Evaluating other options of reducing the risk for your supply chain (see Inventory Management section)
While a vertical integration can be sensible for raw materials, indirect goods such as PPE (Personal protective equipment), will require a different strategy. Either we apply the approach mentioned in “Inventory Management” or we go back to the basics of sourcing and ensure that suppliers do not take advantage during a disruption, e.g.:
- Ensure you ask for the right specifications
- Request certifications and client references
- Get multiple quotes if possible and qualify additional suppliers
- Understand the total value / size of the company
There have been many fake and overpriced products on the market. With speed and cash protection being crucial, companies need to be prepared to source critical products from multiple suppliers quickly and thoroughly.
Digitalize your supply chain
As companies start ramping up production, it will be important to increase the visibility of your supply chain:
- Focus on Tier 1 suppliers: Identify key suppliers (by spend or business criticality) and design reporting KPIs and governance to enable real-time tracking of supplier’s inventory and production parameters. This will help your company to understand the supplier’s flexibility to shift/ramp-up or down production at any given moment in time.
- Increase visibility beyond: It is also essential, to get visibility further down your supply chain on tier 2/3 suppliers, as their performance impacts your suppliers’ abilities to fulfil orders.
After an initial period of tracking your supply chain’s KPIs, agree threshold parameters following a red/amber/green (RAG) logic on which your supplier has to report/flag issues that arise to enable earlier warnings. You should incorporate those metrics as part of your SRM in your ongoing supplier review process.
The maturity of your organization and the industry in which you operate also plays an important role in determining your ability to gain full visibility on your supplier network. Mapping complex supply chains beyond Tier 1 suppliers is traditionally a greater challenge for small and mid-sized companies who lack the digital infrastructure and know-how.
Procurement’s opportunity for visibility in the C-Suite
The sudden disruption due to the COVID-19 virus requires us to rethink our supply chain structure. Even today, leading scientists expect a second wave in Autumn 2020 and similar outbreaks to happen in the near future. As procurement and supply chain executives, we need to apply lessons learnt to our organizations immediately, in order to be prepared for the next disruption.
Our upcoming series will discuss the various topics in detail, helping you to structure your roadmap to a more reliable supply chain.
The applicability of the key themes will vary across industries and geographies; however, some quick fixes can be applied to almost all organizations. It is important for procurement and supply chain executives to act now – there has never been a greater awareness in the C-Suite for supply chain reliability, which in turn provides a high-value opportunity to implement changes with C-level support.