Supply Chains Post-Pandemic: Balancing Risk and Cost

Business owners and supply chain professionals have rarely experienced the supply chain disruptions and failures that have occurred in recent months due to the travel and production breakage resulting from this COVID-19 pandemic. These supply chain challenges are likely to continue for many months, and there is a critical need to react appropriately to minimize the impact and build a more resilient supply chain for the future.

During and post-pandemic, we are seeing middle market companies respond along a continuum from doing nothing to changing 100% of their suppliers. While some companies will do nothing, perhaps citing this as a one-time anomaly, many companies recognize this as a wake-up call and will fully examine their supply chain. A subset of those will build an entirely new supply chain based upon performance and risk reduction. The pandemic has demonstrated that a do-nothing approach in this global, interconnected world assumes a false sense of supply chain security. Local economies will continue to be impacted by global events, medical or otherwise. No geography, country, and certainly no company is immune to the impacts of global disruption, and the potential is high for additional “Black Swan” events with widely felt consequences for the middle market. Given this potential, the new normal for supply chain management professionals should be to take a proactive risk-based approach prior to the next local, regional, or global disruption.

Performance is more than Lowest Cost

For the past 40 years, the supply chain improvement mantra had been “less supply cost and greater flexibility.” To C-level executives in both Fortune 1000 and middle market companies, the mantra has been reduced to “it’s all about cost.” While paying lip service to flexibility, many executives have endorsed building and maintaining supply chains that are lowest cost, and in many cases single source, but not particularly adaptable. These somewhat rigid supply chains, which lack alternate suppliers, hold minimal inventory, and often rely on suppliers a continent away are the most impacted by the COVID-19 pandemic because they cannot adapt to the disruptions experienced during the pandemic.

Prior to 2008-2010 and during that Recession, we encouraged middle market companies to examine their supply chains from a risk as well as a performance perspective. Many middle market executives dismissed risk assessments because cost reduction was the major supply chain improvement driver, and they believed that the “insurance” from risk mitigation did not justify any increase in  costs. “Why would we take on additional cost when only the consultants perceive that risk analysis and risk remediation is beneficial to a middle market company?” We believe the COVID-19 pandemic has taught business leaders some difficult lessons. Risk analysis and risk mitigation steps are critical to building and maintaining a flexible supply chain for your company today and in the future.

Supply Chain Risk Management Today

The tariffs imposed on China in July of 2018 by the US federal government prompted middle market investors and executives to examine their supply chain partners in China. Like other geo-political changes, the cost of goods from China to the United States increased dramatically overnight. Many middle market executives we spoke to in 2018 were more concerned about the cost increase than supply chain disruption and failure. Again, cost trumped risk for most companies.

However, the investment community took a different view. Middle market investors began to look at how much of a company’s raw materials and finished goods came from China, and those with China as the single source for their critical raw materials and/or manufacturing processes became much less attractive as acquisitions. The 2018 tariffs awakened many executives outside of supply chain management to the impact of supply cost and risk for the first time.

The tariffs of 2018 challenged the supply chain risk paradigm for non-supply chain executives, and it was a wake-up call for many middle market supply chain executives. These supply chain leaders have struggled with changing from a lowest cost supply chain model to a more balanced cost and risk effective model. For the past 40 years, these supply chain professionals have been financially rewarded for reducing supply chain costs. Many successful careers have been built on cost reduction with “just in time” inventory. So what happens when middle market CEOs and Boards see an increase in COGS and an increase in inventory associated with risk reduction? The question for many Supply Chain executives is, “are they going to blame me or reward me, and what are the new metrics for supply chain excellence?”

The most successful companies build a competitive moat around their businesses, and this needs to include de-risking the supply chain. The path forward is an agreed upon approach that is endorsed and sponsored by all C-level executives and the Board, focused on supply chain risk mitigation. Without buy-in from all parties, and clear communication down the line, cost and risk will not be considered and managed within the supply chain moving forward. This is the important first step in changing how a company thinks about their supply chain.

 Supply Chain Network Analysis

Most middle market companies grow their supply chain over time to support new customers and suppliers. Rarely do they step back and optimize their supply chains to balance cost, performance, and risk because they were “functioning” and profits were acceptable. The focus was on lower costs and less inventory.

Supply chain networks, which include everything from the firms that supply your suppliers to your end customers, vary in size and complexity in the middle market. For example, Tier 1 and 2 automotive parts companies have larger more complex supply chains than middle market food manufacturers. In recognition of this variation, one size does not fit all middle market companies when conducting a supply chain network analysis. So what options are available?

For larger, more complex supply chains, a network analysis using a modeling tool may be the right first step. These analytical tools (e.g., Llamasoft) allow companies to map their supply chain networks using a multi-variate statistical approach to modeling. Although, in the past, middle market executives have shied away from these analyses because the initial cost was considered too high and they did not understand the financial and risk reduction advantages.

So, how do you know if an analytical modeling approach is appropriate for optimizing your supply chain? Start by collecting supply chain related data from your ERP system that includes the following: all customers and supplier locations as well as your manufacturing and distribution locations. With this data, take out a large sheet of paper and sketch your supply chain network diagram. Make sure you can connect all supply chain entities from the point of supplier procurement to all your end customers across your customers’ geography. If this exercise is easy for you to accomplish in a day or two with accuracy, you probably do not need to use a modeling tool approach. In our experience, many middle market companies find this exercise to be somewhere between challenging and impossible using a manual input and drawing approach. And some do not have the data available to even start the exercise. Because it is time consuming and difficult to document all the interconnection between entities, most middle market companies do not conduct these analyses, instead making do with their organically created, less than efficient, and often risky supply chains. With the supply chain impacts associated with the COVID-19 pandemic, we believe many middle market companies will be rethinking the value of these analyses and will consider a more formal, analytical approach to assessing their supply chain requirements.

Supply Base Analysis

Once a company’s supply chain network is documented, risk points within the supply chain will emerge that need to be addressed. In many supply chains, the greatest risk is found in the supply base which includes raw material and finished goods suppliers. How does this happen?  Many middle market companies have inadvertently created supply risk by buying critical components from a single supplier to reduce procurement costs. Procurement employees learn early in their career that they have better price leverage when they buy more from a single supplier. If they use a secondary or tertiary supplier for components, it will reduce the size of the buy and increase the cost for materials. Again, procurement careers have been made and enhanced based upon getting the lowest cost for raw material and finished goods, not on risk mitigation in the supplier base. Behavior is dictated by metrics and compensation.  Adapting an approach that balances cost and cost risk requires performance metrics to be adjusted and aligned to the new supplier model.

In examining your supplier base, it is important to prioritize your critical components and suppliers first and then follow with the less critical components and suppliers. For your most critical components and suppliers, we recommend a primary, secondary, and tertiary supplier to reduce risk. Importantly, your company has to do business with all suppliers if you to expect them to work with you in challenging times. During the pandemic, suppliers have taken care of their customers first before they added new customers. Companies that are looking for new suppliers during the pandemic are frustrated because they cannot secure cost and risk effective suppliers. This approach is akin to buying car insurance for the first time after your car has sustained major damage.

You may be like many middle market companies looking to reshore or near-shore many of your critical suppliers in the wake of the COVID-19 to reduce supply chain disruption risk. Just as it took 40+ years to offshore supply chain capabilities to China and SE Asia, it will take time to rebuild the manufacturing capabilities in the US and expand capabilities in Mexico and Canada.  And much of this reshoring demand will come from forward thinking middle market companies, who now recognize that by lowering the labor component of manufactured cost, and eliminating the overwater delivery cost, product sourced more locally makes financial sense. The first step inmoving to an on-shore, near-shore approach is gaining executive and Board level approval. Further, these stakeholders should understand that supply chain risk mitigation will take time to implement, but it is necessary to remain competitive and build long-term value.

Business Continuity Planning

Supply chains are only part of the business impact from the COVID-19 pandemic. Customers, employees, equipment, information technology have all been affected adversely by the pandemic. In many cases, Business Continuity Planning (BCP) was limited to systems cutovers and remote working arrangements if workspaces were compromised. Now, business stakeholders appreciate that BCP involves many additional elements, and both Fortune 1000 and middle market companies have scrambled to keep critical components of their operations running in this pandemic. A well-designed BCP includes supply chain risk analysis, but it also includes personnel cross-training, emergency succession plans, facility relocation, backup contract manufacturing, and other mission critical areas.

This pandemic has demonstrated the value of a well-constructed BCP. Like insurance, this is this investment pays off by ensuring your company can continue to function when the unexpected happens.  FortéOne has assisted hundreds of middle market companies in building flexible operations that can absorb the unexpected. If the COVID pandemic has caused you to rethink your supply chain and business continuity planning, call the experts at FortéOne.