Inflation, running in the double digits, is impacting every nook and corner of the manufacturer's operations. To solve the chronic global supply chain disruptions and shortages during the last three years, procurement and finance departments prioritized securing supplies over the worrying price of components and services of raw materials, which further leads to a higher tolerance for price increases. However, manufacturers must now flip the script. It's time for strategies that address both supply and labor shortages and combat rising costs.
The price increases we are experiencing are not really linked to the market or commodity fundamentals. They’re being driven more by broader macroeconomic and geopolitical forces, the grinding Russia-Ukraine war helping to fuel sky-high energy prices and broader, big power politics between the United States and China.
While the impact of current inflation can never be completely mitigated, here are actions that manufacturers are taking to effectively blunt the rising costs and to be better prepared to respond quickly to market changes.
1. Use cost modeling to gain visibility and push back on suppliers’ rising pricing In inflationary times, suppliers frequently exaggerate the overall share of the raw materials in the input costs and use this opportunity to inflate their margins. In contrast, cost models enable companies to quantify how inflation is impacting supplier prices, which components and elements are being impacted more severely, and help scenario planning. By using a robust “should cost” (estimated cost of a product/part/assembly based on cost for materials, labor, overhead, and profit margin) modeling exercise, manufacturers are effectively challenging their suppliers’ higher pricing. One of the world’s largest chemical companies has built and is using a dynamic should cost model for some of their larger spend items around surfactants that enable them to forward-buy the feedstock most impacted by inflation. Locking in prices for the rest of the year helped it beat the market volatility in the near term as well as provide cost transparency.
2. Stop investing in non-strategic spending
Putting the brakes on all non-strategic spending preserves companies’ working capital and flexibility when prices level off or fall. Procurement leaders should thoroughly look at every opportunity to figure out where investments can be pulled back for the time being until the markets stabilize. One of the larger U.S. CPG firms recently pulled back a significant investment with a new supplier to develop a new packaging type as there was no immediate business benefit. Another company, this one based in Europe, put a temporary halt to its sustainable packaging initiative because it cost more than €2 million from a pure CAPEX standpoint. The key to making informed decisions so manufacturers don’t slow or halt investments that will hurt future growth is getting a granular view of all investments and expected ROI.
3. Find a better balance between just-in-time (JIT) and just-in-case inventory buildup
To address the ongoing supply chain shortages and bottlenecks that began with COVID-19, manufacturers shifted from just-in-time to just-in-case to ensure they had ample supplies of key materials on hand to keep their factories humming. However, storage costs on top of the material costs just eat up a company’s cash in an inflationary environment. Inflation is forcing companies to switch back to lean manufacturing and shorter lead times. Finding the right balance between just-in-time vs. just-in-case is now crucial. The third way is to work closely with reliable and long-standing suppliers so they manage a part of your inventory on your behalf at no additional cost. Build critical mass for the high-risk materials to mitigate supply chain disruptions and uncertainties, but be as lean as possible for less critical components and materials by forging a strong relationship with suppliers. Toyota and Apple historically work on a very lean inventory model and continue managing to do so even in the current market conditions owing to the trust and the relationships they have managed to forge with their suppliers. One major success factor in this model would be the supplier’s willingness to hold inventory on behalf of its partner.
Unless the Russia-Ukrainian conflict is resolved, we can expect consistently high energy costs through this coming winter, especially in Europe. While some key commodities are expected to see a downward trend, inflation will continue until spring 2023. Companies, and specifically procurement, need to blunt the impact of inflation and even be prepared for a brief recessionary period.