Next-generation supply chains: Bigger steps, smaller footprints

Published: April 3, 2009

Executive summary

Major shifts in global business conditions are radically altering input costs and risk. In response, companies must realign their supply chains around new assumptions to meet the multidimensional challenges of today’s marketplace. That effort must include rethinking product formulation and packaging, restructuring the supply chain network and footprint, and realigning the role of suppliers and third parties. While the right answers will vary by company, they will generally require bigger steps than recent improvement initiatives, resulting in smaller product and network footprints. These changes will improve efficiency, resiliency, and sustainability, while allowing for more responsive supply chains with greater flexibility to support growth.

New conditions challenge past strategies

Just when it seemed safe to follow orthodox, tried-and-true supply chain strategies based on some very simple and consistent ideas, major shifts in global business conditions have rendered invalid some of our most critical assumptions, especially those related to input costs and risk. Now companies must realign their supply chains around new assumptions to meet the multidimensional challenges of today’s marketplace.

Over the past few decades, manufacturers have built longer and more complex supply chains, driven by the notion that certain conditions are immutable: low energy and transportation costs, cheap labor and scarce environmental regulations in developing nations, relatively inexpensive raw materials, and advantageous currency exchange rates in established markets.

Manufacturers found they could save significant amounts of money by consolidating and shelving plants in the West while expanding supply networks deeper into low-cost countries, mainly in Asia and eastern Europe — farther and farther from the demand in developed markets. In many cases, they moved production offshore completely. They did all this without seriously considering that these longer supply chains might someday increase costs or create unmanageable risks to product supply, quality, and safety.

But recent, unexpected, and volatile shifts in input costs have called into question — and in some cases already invalidated — the wisdom of these strategies. As a result, major supply chain realignment is fast becoming a necessity for many manufacturers.

The most widespread impacts have come from the dramatic increase and subsequent fall in the price of oil and its derivatives. Simultaneous strengthening and then erosion of currencies such as the euro and real have magnified these impacts for key producers and markets. U.S. commodity prices rose 174 percent between January 2006 and June 2008 before falling by 25 percent in the second half of 2008. Commodities from copper to corn show a similar pattern and high volatility (Exhibit 1).

Exchange rates and energy and commodity prices drive volatile supply costs

Variability in demand coupled with the volatility of the inputs has had a tremendous impact on supply chain costs and performance. This is particularly true for companies that have farmed out more and more manufacturing to third parties and, in so doing, ceded control of the purchasing process (including negotiating prices) for raw materials.

Not as conspicuous but just as disruptive are recent increases in other costs, such as labor and packaging — especially in developing economies, where large changes in consumer demand drive inflation or volatility for exchange rates, material prices, and wages. And just when almost everything costs more, manufacturers can no longer expect to save money by taking advantage of lax regulations in emerging nations. New and sometimes expensive environmental protection rules are increasingly being adopted to curtail carbon emissions, protect water supplies, and dispose of waste.

These changes reflect fundamental shifts in supply and demand, exacerbated by continuing volatility in the market, as well as intractable alterations in regulatory, social, and cultural conditions. Hence, they have long-term implications for the future of supply chain alignment and strategies. For example, the recent run-up in oil prices reflected growth in global demand, and a supply that was relatively inelastic and vulnerable to disruptions. However, per-barrel costs have plummeted amid economic turmoil as demand adjusted downward in response to slowdowns in economic growth. But it is highly likely that the cost of oil will increase again once economic recovery begins. The US$30-a-barrel price assumption underpinning current supply chain structures will be inadequate. Similarly, population growth and economic development will propel raw material and other manufacturing costs higher in emerging markets, and environmental concerns will thrust on producers the costs of keeping their “neighborhoods” clean and their operations green.

Simply put, these changes will require manufacturers to make broad adjustments in their products and processes and set in motion aggressive initiatives to realign supply chains. Incremental efforts toward supply chain efficiency, so routine in the past, will not be enough to offset the rising costs of inputs — or deliver the essential capabilities that will be required for long-term competitiveness. Difficult questions will have to be addressed: To what extent do price changes represent a temporary or cyclical condition — and when should they be viewed as a new normal, reflecting fundamental shifts in supply and demand? Should we realign our supply chain assuming the price of oil at $30 per barrel or $150? How do we best meet expanding demands for growth and customer service while realigning supply chains to increase efficiency, sustainability, and resilience? Where should we put our factories? Should we make or should we buy? Which costs will be the most volatile in the next five to 10 years? What will conditions be like in developing nations such as China a decade from now? What major steps are critical to ensure essential advantage?

In our view, while these are tough strategic questions — and uncertain issues — manufacturers can best address the underlying challenges with three efforts focused on realigning their products and supply chains for the new realities.

  • Rethink product formulation and packaging.
  • Restructure the supply chain network and footprint.
  • Realign the role of suppliers and third parties.

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Next-generation supply chains: Bigger steps, smaller footprints

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