In the midst of a brutal global recession and huge uncertainty around everything from commodity prices to supplier viability, companies are faced with making critical supply chain decisions- decisions that will help them not only get through the current downturn but that will position them to outperform the competition when recovery comes.
Strategic and tactical choices made today will have implications far beyond the immediate throes of this crisis, says Greg Cudahy, global head of the supply chain strategy practice at Accenture, a New York-based consulting firm. Studies by Accenture of the 1990-1991 recession show that companies that made smart and strategic cost cuts and investments during that contraction far outpaced average performers when recovery came. (See chart.)
That lesson is further underscored by assessing companies that are suffering least today, says Cudahy. "Attention to the supply chain marks the single biggest difference we are seeing in performance between companies in the current recession," he says. Businesses that used the time since the last recession to strengthen supply chain strategy and improve execution "may be missing earnings by a little, but they are not losing money quarter after quarter. I think that two quarters from now, the difference between supply chain 'haves' and 'have nots' will be even more obvious." He adds that companies with more variable than fixed costs in the supply chain "are much better off."
Brad Mitchell, president of global logistics and distribution at UPS, Atlanta, agrees that companies that added planning and forecasting capabilities and adopted outsourcing strategies in the past three to five years "are in a somewhat better position today. They freed up hard assets, whether warehouses, trucks or something else, and that left them more flexible and resilient, able to scale down in this environment and, presumably, to scale back up when things improve." However, "there is no single, bullet-proof strategy to protect against a drop in consumer demand of this magnitude," he says.
Perhaps the biggest advantage for these better performing companies is the multiplier effect. Because they are hurting less now, they are in a better position to continue investing through this recessionary cycle, which should enable them to emerge even stronger.
"Those companies with a foundation and margin that allows them to do so are using this downtime as an opportunity," says Danny Halim, vice president for supply and manufacturing solutions at JDA Software, Scottsdale, Ariz. "We actually are seeing a pickup of interest from customers in the next level of supply chain technology, whether that is inventory optimization, more investments in demand planning or additional capability on the logistics side." Everyone, however, is being more cautious and selective with spending, he says. "People are interested only in projects that have a fast return on investment-within six to eight months."
Given that all companies are facing resource restraints, what supply chain changes should they make to both immediately reduce costs and meet long-term goals?
Most experts begin by emphasizing the one thing they should NOT do, which is to impose "slash and burn," across-the-board spending cuts.
"In times like these, the first tendency is to just cut, cut, cut, but that is not the answer," says Gene Tyndall, executive vice president-global supply chain at Tompkins Associates, supply chain consultants and integrators based in Raleigh, N.C. "With that approach they will come out of the recession no better off then they were going in."
The Accenture graph that accompanies this article demonstrates that fact very well, says Cudahy. "If two companies go after similar levels of cost reductions and one goes through slash-and-burn cuts while the other takes a more surgical and strategic approach, the second company will come out way ahead every time," he says. Even though the two companies may take some of the same steps to reduce costs, "the more strategic one will siphon off a small percentage of the savings for future improvements or to retain critical skill sets. For example, the company that has only a short-term focus will typically lay off its most expensive people, but those are the people it will need the most when things pick up."
The best place to begin cutting costs may actually be to cut revenue, says Frank Burkitt, principal at Deloitte Consulting, New York. This advice refers to the "bad" revenue that undermines profitability, he says. "The idea of cutting revenue in a downturn might seem crazy, but simply put, some customers are not worth serving and some products are not worth selling," he says. "The shrinking margins that accompany an economic slowdown often only make the problem worse. Executives need to use top-down revenue cutting and bottom-up cost cutting approaches. Decide which revenue streams are not worth preserving and then target cost reductions," says Burkitt.
Some short-term opportunities are too tempting-and perhaps too necessary-to resist, however. With transportation costs, many companies are reacting by forcing carriers to reduce rates.
"There is more freight bidding activity going on now than there has ever been," says Tom Sanderson, president of Transplace, a third-party provider of transportation services and logistics technology based in Dallas. "We see a lot of shippers putting their total transportation out for bid, even if this is not their normal bidding cycle. They are asking trucking companies to provide price, service and capacity commitments for the next 12 months. Manufacturers and retailers know that they can save money by doing that because the freight market is so soft right now," he says.
In addition, the credit crunch is causing shippers to push carriers to extend terms of payment to 60 or 90 days, says Sanderson. "This is unfortunate from the standpoint of the trucking companies because their costs certainly haven't gone down and they also are cash constrained. But it is a very weak trade economy and everybody is looking at whatever they can do to take some costs out of the system."
Jim Wetekamp, senior vice president of solutions strategy at BravoSolution, agrees that companies "can get pretty big reductions in rates" with this tactic. Many don't even put their freight out to bid because they can get significant reductions simply by renegotiating with incumbent carriers, he says. "A much better long-term strategy would be for companies to take this opportunity to make some corrections in their carrier base and in how they are working with their carriers. Such changes are easy to do now when capacity is high, but it will be a lot harder when the market turns," he says. BravoSolution, Malvern, Pa., provides supply management solutions to a range of industries.
There are ways other than rate cuts to get quick reductions in logistics costs, says Dan Sanker, CEO of CaseStack, a logistics provider based in Santa Monica, Calif. "We still see consolidation across our base of companies as offering the best opportunities for savings," he says, noting that CaseStack has developed numerous variations on the consolidation theme. One uses proprietary software to consolidate into full truckloads freight from different suppliers going to the same retail customers. "With this program, we can save customers up to 40 percent on transportation costs while improving service to the retailer and reducing carbon emissions," he says. "Why would anyone not look at that? Even when you consider the costs of shifting from current providers or changing internal processes, the savings are so substantial they will pay back those expenses in a matter of months."
One focus at Transplace is to help customers get better productivity from their private or dedicated fleets, says Sanderson. By matching backhaul capacity with shipments from its broad customer base, Transplace is able to reduce empty miles and lower costs, "which is good for participating companies and for the environment," he says.
Logistics outsourcing in general is a way to move from fixed to variable costs and free up cash. For these reasons it is being looked at even by companies that have eschewed it before. "The number and type of customers that are willing to consider outsourcing is changing as companies reexamine their total costs," says Bill Villalon, vice president, land transport services and product development, at APL Logistics, Oakland, Calif. "There is unquestionably a greater willingness by companies today to listen to alternative methods of doing business. Given the cost pressures that are on them, they are realizing that just tweaking their existing business model may not be enough. They may have to fundamentally rethink how they do business."
In some cases, this can mean outsourcing non-traditional chunks of the supply chain, such as global trade management or even planning functions. This managed services approach is often a case of just having a third-party run the software, says Tyndall. "Having a third-party actually responsible for planning, I would say, is too risky," he says. "Planning is an area where companies really need to keep control."
The concept of managed services is finding proponents in this economy, however, among companies that need help with quick-win projects, says Halim. "We are having more people inquire about managed service options. This may be because their IT budget is frozen and the business unit championing the project just can't get the money for a capital investment, even though the project has value."
Outsourcing also is showing up as a way to free up resources devoted to back office functions, says Roy Lenders, vice president, global supply chain management, at Capgemini Consulting, Paris. "We see a lot of projects where companies are off-shoring back office processes in a managed services model to providers like Capgemini." He notes that Capgemini has a large contract with major consumer goods company under which about 800 workers in India provide back office support for supply chain processes, from materials procurement to distribution and transportation planning.
Another basic cost cutting strategy that companies typically turn to when the economy heads south is shifting freight to less expensive transportation modes. "The most prevalent shift we see currently is the movement away from air cargo to ocean or truck," says Lenders.
"A lot of companies are trading down in terms of moving more products via ocean and rail," agrees Mitchell of UPS. "If companies find they can plan for and manage the longer transit times involved, this may become a permanent solution for some of those industries."
As with other cost-cutting measures mentioned here, the likelihood that changes will stay in place after the recession is greatly increased by the probability that oil will renew its upward climb as the economy recovers. "I think everyone believes it is only a matter of time before fuel goes up again," says Sanderson. "This creates a real challenge for companies right now because you can't design a strategy around $2 a gallon diesel."
Last year's fuel spike clearly served as a catalyst for many companies to start questioning whether it still makes sense to source a large percentage of goods from Asia and, particularly, from China. Even as fuel prices dropped, this issue remained a hot topic of discussion because it is not just about transportation costs, says Cudahy. "Even before the fuel issue, companies had begun to realize these lengthy supply chains were causing them to hold a lot of inventory across the system in order to deal with replenishment. Now, with the financial crisis causing problems around funding inventory, there is added pressure to incorporate more hemispheric sourcing."
This recession has really demonstrated the significant downside potential that exists for companies that don't have the flexibility to deal with demand volatility," says Lorcan Sheehan, senior vice president of marketing at ModusLink, Waltham, Mass., a provider of business process management solutions. "Look at the lead-time implications. If you are using a contract manufacturer in Southeast Asia, it can take eight to 12 weeks to have a product manufactured, followed by four to five weeks on the ocean. Given the lack of certainty in today's market, that is just not an acceptable position."
Risk concerns also are a driver, with companies wanting more diversification in their supplier base, geographically as well as individually.
Just as there was a significant move of manufacturing to China after the last recession, there could be a similar, though much smaller, move in the other direction after this recession, says Ron Keith, COO for Riverwood Solutions, Menlo Park, Calif. "After the last downturn, China was never the wrong answer, but a lot of those decisions were made without really looking at total delivered costs. I think people are now getting a holistic understanding of all the supply chain costs associated with outsourcing. That, coupled with growing customer demand for more flexibility, will start to drive activity on near sourcing."
Riverwood, which provides managed supply chain services for companies involved in contract manufacturing, finds some support for this view in a proprietary survey of global OEMs that it conducted in March. This is a quarterly survey of senior operations and supply chain professionals at 75 electronic products OEMs, which last year spent more than $150bn in the global electronics supply chain. "We asked respondents to rate their position on the statement, 'I believe China is the best location for me to manufacture my products at this time,'" says Keith. "The affirmative response out of our pool was only 23.5 percent. I would have expected 62 or 63 percent to respond affirmatively and would have been surprised at 50 percent. To see only 23 percent really shocked me."
Just over 53 percent of OEMs plan to geographically relocate some of their production within the next two quarters, according to the survey, though the destination of these relocations was not part of the survey. "The current economic environment will create not only serious dislocations but also tremendous competitive opportunities in the electronics supply chain over the next few years," Keith says. "Difficult economic times often create the catalysts for dramatic shifts in the way companies do business."
Whether these shifts will include a major pullback of manufacturing from Asia remains to be seen. Many believe it will not. "Asia still has a lot of advantages, including labor costs and scale economies that are quite significant," says Villalon. "Those will not be easily outweighed." Certainly not by transportation costs, he adds. "Ocean transportation is still the most efficient and low-cost mode. If you start putting a pencil to what it costs to truck something out of Mexico into the U.S., it is still significantly higher than trans-Pacific ocean transport." So far there are only anecdotal examples of companies shifting manufacturing back to this hemisphere, he says. "I don't think we'll see much real action."
Others believe that some companies will make moderate changes as they adopt a mixed lead-time strategy. This type of strategy "will allow companies to continue taking advantage of the relatively lower manufacturing costs in China and other countries for most products, while sourcing some goods closer to the U.S., perhaps in Mexico or South America, in order to respond faster to changes in demand," says Halim. "This alternative will increase the cost per unit from a manufacturing standpoint, but it will provide needed flexibility and lower risk. For example, a retailer might purchase enough from China three months in advance of a selling season to load the channel, then augment inventory from sources near shore."
On the domestic front, these same drivers are causing some companies to rethink distribution strategies. One change being adopted by some companies is to position more inventories closer to the customer in smaller regional warehouses.
"Where companies providing North American distribution used to have just one or two large warehouses, that now seems to be expanding into maybe five," says Jeff Adams, executive vice president at Freight Solution Providers, a freight forwarder based in Sacramento, Calif. "If a company has less geography to cross, its transportation costs are lower and it can provide overnight service to customers within the region," he says. "We see many companies doing this."
"More and more buyers want shorter response times," says Tyndall. "So instead of the traditional hub-and-spoke network where a company runs a truck out of a hub like Chicago for two days, we are seeing more smaller DCs closer to the point of sale." While this activity also was spurred by high fuel prices, it now is being driven by price uncertainty, he says.
"It really comes down to how urgently you I have to get this product to your customer," says Mitchell. "In the service parts world, if a customer has to get a machine or server failure back up within an hour, those parts must be immediately available. But if your product is a $10,000 mother board, a centralized model may work best. It comes down to individual products."
Better segmenting products may provide the best answer, says Burkitt. For example, an apparel manufacturer may want a quick time-to-market strategy for fast-moving sizes but could centralize fringe sizes and perhaps provide some special service around that, such as express shipments to the consumer's door. "Of course, the first thing a transportation guy will say is, 'you just increased my freight costs five times.' But you also reduced the handling of those SKUs and improved performance by focusing on your A items." These are not the decisions that will drive your core business, he says, "but they can differentiate you from your competitors."
"Flexibility is the key," says Sheehan. "Companies need flexibility to protect against the downside and flexibility to react when things pick up. At some point demand will turn and you don't want to be facing a 13-week to 16-week lead-time to get products on the shelf."
While everyone agrees that this recession will end, they do not necessarily think that everything will return to the way it was. "I think this period may potentially mark a shift to a whole new economic climate where there is much less stability and much more volatility and uncertainty," says Cudahy. "Significant uncertainty may be the new normal."
Economy Hasn't Snuffed Sustainability
In the current economic crisis, it would not be surprising to see sustainability initiatives get pushed to the back burner. While that clearly is the case in some companies, for many others sustainability remains an unexpectedly strong driver in decision making.
JDA Software, www.jda.com
Tompkins Associates, www.tompkinsinc.com
Deloitte Consulting, www.deloitte.com
APL Logistics, www.apllogistics.com
Capgemini Consulting, www.capgemini.com
Riverwood Solutions, www.rwsops.com
Freight Solution Providers, www.shipfsp.com
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