The U.S. released its second-quarter GDP figures at the end of July. Analysts estimate that the economy shrank as much as 35 percent because of the pandemic. Federal Reserve Chairman Jerome Powell said yesterday that the pace of economic recovery is slowing down as COVID-19 cases continue to surge.
This is all the evidence we need to realize doing business in the future will not be as before. Supply chains have always had risks and variables to understand, but now more than ever leaders need to understand total landed cost and apply a more comprehensive risk management strategy, not just cheaper labor from other countries.
Add to that, the challenge of building in more flexibility across a supply chain network, using a more strategic approach. If you are concerned about building a more flexible supply chain, the place to start is assessing your own current state. Let's review each of these topics briefly today.
Flexibility: the ability to flex up or down according to immediate needs of your customers and the marketplace without creating new liabilities for you and your supply chain that may exceed the savings in inventory or exposure to risk of changes in demand.
This includes several considerations starting not with suppliers, but with your own organization, including:
After you understand where your own flexibility may provide options, then you can go to the marketplace to find the right supplier based on your needs and establish a good relationship with this new supplier over time.
It's helpful to know that you probably do have some choices and maybe you should explore more options more deeply.
Here is a case study as one example where the purchasing side had few good choices, not much flexibility, zero tolerance for substitution and a relatively short lead time that was lean and low average inventory overall.
A manufacturing firm was consuming a small amount of forged flanges per year with about 27 different part numbers they purchase regularly. Some of the items had volumes of hundreds per week and some with volumes of 10 per year. It's the classic 80/20 rule with just a few part numbers driving 80 percent of the volume. Their local supplier provided an average lead time of about two weeks for non-stocked items and a Kanban of higher-volume parts that was refilled weekly. Quality specifications for this material was high quality with no detectable scratches in the sealing surface; all materials must be certified for content.
This company was one of many divisions in a larger conglomerate with a central commodities management group that was tasked to find cheaper suppliers that all divisions could purchase from and based on larger total combined volumes, receive lower unit pricing. The local manufacturer was successful with local sourcing in the U.S. and had a good track record for delivery and quality after several years of continued process improvement initiatives that paid handsomely over time. The manufacturer enjoyed a relatively short lead time to fulfill their orders and consistently provided 98+ percent on-time delivery (OTD).
As you might expect, this new mandate from the centrally managed corporate commodity program found a Chinese supplier of flanges that all the divisions could leverage collectively for a much lower price. The assurance for sufficient quality was also provided.
But that is where the good news stopped. The manufacturer was compelled to use this new Chinese supplier. The lead time for purchasing grew from two weeks to 14+ weeks, meaning they were now very dependent on more accurate forecasting and higher levels of inventory to protect the variations in demand inherently present with longer lead time. The reject rate for QA rose from 0.5 percent rejects to around 30 percent. The amount of inventory required to maintain operations grew by more than 300 percent.
Sourcing from China also meant added complexity of customs, duties to pay, and more lead time for transit on the ocean for heavy parts. The company had no choice but to spend money, time, and resources on in-house repair of defective parts just to keep their production line going.
In the end, this manufacturer's costs rose dramatically on more than half of the items purchased from the Chinese supplier, making them actually cost more in terms of total landed cost per unit. Due to the cost of inventory, the carrying costs rose by more than a factor of 4X. Add to that the quality impact causing delays in production and the OTD performance fell from 98 percent where it had been for years, to about 78 percent for many months until this low-cost material could be eliminated from the supply chain.
This was a classic example of not understanding the total landed cost and the tradeoffs that come with offshore suppliers where you typically lose a fair amount of control.
Now, let's discuss risk management. This same manufacturer must consider, how much added risk are they willing or able to tolerate and at what added costs. Beyond the total landed cost elements, this manufacturer also had to send quality engineers to the supplier's production site to audit the production process looking for reasons for inconsistent quality outputs. They had no ability to do anything more than audit the supplier's processes and report back. The supplier complied in some areas, but sadly, not all. This adds more indirect costs to the sourcing equation, and at the end of the day, there is little if any guarantee your parts will continue to come from the facility your inspectors audited once they have left the site.
Risk comes from variation. Inconsistent process controls, inconsistent quality objectives, and lack of management oversight. Inconsistent visibility into supplier sourcing practices, labor management, capacity utilization, and assignment of production to secondary sources without you ever knowing.
These factors may never show up, or they may have a compounding effect that can shut you down without notice. How well are you able to switch to another supplier if you really needed to? That is not always an option that can be accomplished within a year.
There is a lot that can be positive in an outsourcing project, when the right fit is achieved. If the only objective is cost cutting, don't be surprised if you make poor choices, at least at first. When you begin to make outsourcing decisions based on expansion capabilities, leveraging innovation for value, cost effective capacity that offers your greater flexibility, then you begin to realize new gains.
A 2016 survey from Deloitte covers many aspects of outsourcing, not just offshoring, that you may find helpful. It is a public document you can learn a lot from to guide your future strategy planning and execution more thoughtfully.
One more item that is on everyone's mind now: Based on COVID-19 interruptions, what else should we consider?
A simple answer: This probably means revisiting the list of questions to explore more deeply the possibility of interruptions to your supply, how likely this kind of event might be again and what the impact might be. Deciding what leading indicators, you would need to watch for might be an option but would be different for each scenario you consider. I suspect more firms are seriously re-evaluating this question now.
The reality here is that once your firm has committed to a path, and the documented cost structure, it becomes exceedingly difficult to extricate your supply chain from a chosen path. Most firms still to this day do not fully understand total landed cost and unfortunately, ERP systems generally do a less than stellar job providing the right data out of the box. We still have unit cost and purchase price variance as the driving forces in too many sourcing decisions.
For a deeper analysis on your strategic sourcing program, contact SupplyChainPro2Know's Bob Forshay at firstname.lastname@example.org.