Executive Briefings

How the Soaring Price of Oil Is Affecting Supply-Chain Strategies

A conversation with Tim Feemster, senior vice president of global logistics with Grubb & Ellis Co.

No one is immune from the impact of rising oil prices, least of all global supply chains. More than half the cost of getting products to market is related to transportation and fuel. At a certain point, companies are forced to alter their networks, leading to major changes in sourcing as well as the size and location of key distribution points. The savings that come from manufacturing in regions with cheap labor can be wiped out by the cost of moving goods over long distances. Routing choices in the U.S. can be affected as well. In this conversation with Tim Feemster of Grubb & Ellis Co., conducted at Aberdeen's Supply Chain Management Summit in Chicago, we discuss the factors that can lead to a "tipping point" in supply-chain strategy, in particular the price of oil.

Q: How important is the rising cost of fuel to supply chains today?

A: Feemster: The latest CSCMP [Council of Supply Chain Management] study showed that 62 percent of supply chain costs were transportation and fuel. The rising price of fuel is a big driver to that. Everybody in the global supply chain is being impacted. We're at $3.93 cents a gallon for diesel today. That's a 21-percent increase over the first quarter of 2009. It's actually higher than the first quarter of 2008, when we reached our peak fuel price of $4.76 a gallon. It's starting to have a big impact, both on the transportation industry and on the consumer.

Q: The trend for many companies in recent years has been to consolidate the number of distribution centers and get better efficiencies out of fewer, larger facilities. Is that turning around now, because higher fuel prices have made it necessary?

A: Feemster: Correct. As oil reaches that trigger point, probably somewhere between $125 and $150 a barrel, it's going to have an impact on network design. People are going to go away from this regionalization that we've seen over the last 20 years, back to a more market-centered approach. You'll have more distribution centers in the future at $150 a barrel. The overall cost of your supply chain - over 50 percent in transportation, 22 percent in inventory carrying costs, 17 percent in labor and 4 to 5 percent in rent - will be less. That will be true even if you're paying more for rent, labor and inventory, because your transportation cost will have gone up so much that it [exceeds] the others.

Q: That's a pretty amazing thought, that transportation costs would become so high as to overwhelm all those other costs.

A: Feemster: MIT has done some studies on this. They were looking at a consumer products company which had five distribution centers, all the way up to $125 a barrel. As soon as oil went to $150, it went to seven.

Q: Are we going to see more near-sourcing of manufacturing, among companies that had shifted production to China?

A: Feemster: We very well could. Again, it depends on how high is high, in terms of the fuel cost. On the near-sourcing side, the most obvious option is Mexico. But there are significant problems there from a security perspective, so a lot of companies are shying away from Mexico and going to other South and Central American countries. Or they could come back to the United States. Again, it's a matter of whether the cost of transport all the way from Asia overcomes the higher cost of labor in the United States.

Q: There are other recent factors that seem to be working against the idea of sourcing in Asia, such as higher labor costs in China and the Japanese earthquake. Does all of this combine to make sourcing in the Western hemisphere more viable in the short term?

A: Feemster: Correct. But some companies ought to consider the option of taking a percentage of their product and near-sourcing it, and keeping a portion of it offshore-sourced. Then they'll have a faster response time. Take the example of a company that might produce 80 percent of its product in Asia and 20 percent in North America, whether Mexico or the U.S. It has two different supply chains in terms of time to market. It's got a 40- to 60-day response time on 80 percent of its product, but if it gets a spike in sales on purple sweaters, it can near-source that production and get it to market faster. That strategy doesn't impact total supply chain costs as much as if the company had brought all of it back to the U.S., where there's a higher cost of labor.

Q: How about segmenting sourcing based on product maturity - with generic product being made in a more distant place, and the finished version created closer to market, in a postponement-type strategy? Might that practice become more popular?

A: Feemster: That's another good point. Postponement allows you to not configure the product until you've actually got the orders, or are very close to having them. Then you can respond very quickly. It helps you to overcome long lead times from Asia, while attacking that 22-percent cost of inventory.

We did this with one client I had in a company that I previously worked for. It had product that carried a number of brands. After the company combined three different networks, it genericized its packaging, with a little window in the box where we could place brand-name labels. When a product was installed at the customer's location, the label could be applied for whichever brand name the customer had bought. The company cut inventory by a third and improved service to the client, because it now had one product to pull from.

Q: Let's talk about transportation patterns. The trend in trans-Pacific imports has been a greater reliance on all-water service to East and Gulf ports, at the expense of the West Coast. Will we see some shipments moving back to the West Coast?

A: Feemster: It's going to be two-pronged. Last year saw a reversal of that trend, in terms of the percentage of container movements. The West Coast actually gained back share, compared with a decline between 2006 and 2009. Part of that was driven by the fact that it's the fastest way to the Midwest and even many eastern locations. Manufacturers reduced inventories in 2009, then had to respond to a good Christmas and better consumer spending in 2010. They had to use the West Coast to get goods there faster.

I think, however, that the increase in fuel costs is going to be a wild card, along with expansion of the Panama Canal. A ship represents the lowest unit cost per mile traveled. As ships transit the canal, the reduced cost of all-water service to the East Coast will offset the impact of higher inventory carrying costs, even with voyages taking longer.

Q: What about trends in ship size?

A: Feemster: Trust me, steamship lines are moving to the bigger ships. It used to be that a big ship was 5,000 TEUs [20-foot equivalent units]. Today it's over 13,000 TEUs. It takes 13 people to handle either size. Plus [the larger ships] are more efficient, the diesel engines are better, and they go through the water better.

Q: What's the most important thing that companies can do to mitigate the impact of higher fuel costs on their supply chains?

A: Feemster: They need to look at their network design, but not with historical transportation costs. To take advantage of low lease rates today, you might be tempted to make long-term arrangements in most of your facilities. But in two or three years, you want to be able to move without a penalty. So the first thing is to conduct studies on the basis of future cost expectations. And the second is that you have to look at modal shifts between truck and intermodal, and between the West Coast and all-water to the East Coast. You want to be able to reduce the impact on transportation of the higher price of fuel.

Resource Link:
Grubb & Ellis Co.

To view video in its entirety, click here 

 

A conversation with Tim Feemster, senior vice president of global logistics with Grubb & Ellis Co.

No one is immune from the impact of rising oil prices, least of all global supply chains. More than half the cost of getting products to market is related to transportation and fuel. At a certain point, companies are forced to alter their networks, leading to major changes in sourcing as well as the size and location of key distribution points. The savings that come from manufacturing in regions with cheap labor can be wiped out by the cost of moving goods over long distances. Routing choices in the U.S. can be affected as well. In this conversation with Tim Feemster of Grubb & Ellis Co., conducted at Aberdeen's Supply Chain Management Summit in Chicago, we discuss the factors that can lead to a "tipping point" in supply-chain strategy, in particular the price of oil.

Q: How important is the rising cost of fuel to supply chains today?

A: Feemster: The latest CSCMP [Council of Supply Chain Management] study showed that 62 percent of supply chain costs were transportation and fuel. The rising price of fuel is a big driver to that. Everybody in the global supply chain is being impacted. We're at $3.93 cents a gallon for diesel today. That's a 21-percent increase over the first quarter of 2009. It's actually higher than the first quarter of 2008, when we reached our peak fuel price of $4.76 a gallon. It's starting to have a big impact, both on the transportation industry and on the consumer.

Q: The trend for many companies in recent years has been to consolidate the number of distribution centers and get better efficiencies out of fewer, larger facilities. Is that turning around now, because higher fuel prices have made it necessary?

A: Feemster: Correct. As oil reaches that trigger point, probably somewhere between $125 and $150 a barrel, it's going to have an impact on network design. People are going to go away from this regionalization that we've seen over the last 20 years, back to a more market-centered approach. You'll have more distribution centers in the future at $150 a barrel. The overall cost of your supply chain - over 50 percent in transportation, 22 percent in inventory carrying costs, 17 percent in labor and 4 to 5 percent in rent - will be less. That will be true even if you're paying more for rent, labor and inventory, because your transportation cost will have gone up so much that it [exceeds] the others.

Q: That's a pretty amazing thought, that transportation costs would become so high as to overwhelm all those other costs.

A: Feemster: MIT has done some studies on this. They were looking at a consumer products company which had five distribution centers, all the way up to $125 a barrel. As soon as oil went to $150, it went to seven.

Q: Are we going to see more near-sourcing of manufacturing, among companies that had shifted production to China?

A: Feemster: We very well could. Again, it depends on how high is high, in terms of the fuel cost. On the near-sourcing side, the most obvious option is Mexico. But there are significant problems there from a security perspective, so a lot of companies are shying away from Mexico and going to other South and Central American countries. Or they could come back to the United States. Again, it's a matter of whether the cost of transport all the way from Asia overcomes the higher cost of labor in the United States.

Q: There are other recent factors that seem to be working against the idea of sourcing in Asia, such as higher labor costs in China and the Japanese earthquake. Does all of this combine to make sourcing in the Western hemisphere more viable in the short term?

A: Feemster: Correct. But some companies ought to consider the option of taking a percentage of their product and near-sourcing it, and keeping a portion of it offshore-sourced. Then they'll have a faster response time. Take the example of a company that might produce 80 percent of its product in Asia and 20 percent in North America, whether Mexico or the U.S. It has two different supply chains in terms of time to market. It's got a 40- to 60-day response time on 80 percent of its product, but if it gets a spike in sales on purple sweaters, it can near-source that production and get it to market faster. That strategy doesn't impact total supply chain costs as much as if the company had brought all of it back to the U.S., where there's a higher cost of labor.

Q: How about segmenting sourcing based on product maturity - with generic product being made in a more distant place, and the finished version created closer to market, in a postponement-type strategy? Might that practice become more popular?

A: Feemster: That's another good point. Postponement allows you to not configure the product until you've actually got the orders, or are very close to having them. Then you can respond very quickly. It helps you to overcome long lead times from Asia, while attacking that 22-percent cost of inventory.

We did this with one client I had in a company that I previously worked for. It had product that carried a number of brands. After the company combined three different networks, it genericized its packaging, with a little window in the box where we could place brand-name labels. When a product was installed at the customer's location, the label could be applied for whichever brand name the customer had bought. The company cut inventory by a third and improved service to the client, because it now had one product to pull from.

Q: Let's talk about transportation patterns. The trend in trans-Pacific imports has been a greater reliance on all-water service to East and Gulf ports, at the expense of the West Coast. Will we see some shipments moving back to the West Coast?

A: Feemster: It's going to be two-pronged. Last year saw a reversal of that trend, in terms of the percentage of container movements. The West Coast actually gained back share, compared with a decline between 2006 and 2009. Part of that was driven by the fact that it's the fastest way to the Midwest and even many eastern locations. Manufacturers reduced inventories in 2009, then had to respond to a good Christmas and better consumer spending in 2010. They had to use the West Coast to get goods there faster.

I think, however, that the increase in fuel costs is going to be a wild card, along with expansion of the Panama Canal. A ship represents the lowest unit cost per mile traveled. As ships transit the canal, the reduced cost of all-water service to the East Coast will offset the impact of higher inventory carrying costs, even with voyages taking longer.

Q: What about trends in ship size?

A: Feemster: Trust me, steamship lines are moving to the bigger ships. It used to be that a big ship was 5,000 TEUs [20-foot equivalent units]. Today it's over 13,000 TEUs. It takes 13 people to handle either size. Plus [the larger ships] are more efficient, the diesel engines are better, and they go through the water better.

Q: What's the most important thing that companies can do to mitigate the impact of higher fuel costs on their supply chains?

A: Feemster: They need to look at their network design, but not with historical transportation costs. To take advantage of low lease rates today, you might be tempted to make long-term arrangements in most of your facilities. But in two or three years, you want to be able to move without a penalty. So the first thing is to conduct studies on the basis of future cost expectations. And the second is that you have to look at modal shifts between truck and intermodal, and between the West Coast and all-water to the East Coast. You want to be able to reduce the impact on transportation of the higher price of fuel.

Resource Link:
Grubb & Ellis Co.

To view video in its entirety, click here