Our supply chains were already under stress. The last thing we needed was for inflation to come and muddy the waters.
After years of runaway inflation in the 1970s and 1980s, the world’s major economies had done a good job of keeping them in check in recent years. But all of that progress seemed to have petered out after a period of pandemic-driven consumer spending and disrupted supply chains. Now, despite regulators’ best attempts to rein in inflation, we are seeing inflation picking up.
What can supply chain managers do to mitigate the impact of high inflation? To find out, David Maloney – the group’s editorial director supply chain quarterly’s sister publication DC Velocity – recently spoke with Paul Lord for an episode of the Logistics Matters podcast. Lord is senior director of research and analyst in the supply chain practice at consulting firm Gartner. He regularly provides clients with research insights, advice and thought leadership in the areas of inventory management and cost optimization. Lord joined Gartner in 2009 with the company’s acquisition of AMR Research.
Q: The world is facing the highest inflation rates in decades. How has this affected our supply chains? I can imagine that there is more to it than just increasing costs.
A: You are right that there is more to it than that. But the main result of inflation was certainly higher costs for a whole range of resources. It affects labour, energy, materials and logistics services, so it’s really pervasive, and of course each company is affected in different ways depending on how these resources are used.
For example, service-intensive industries are much more affected by higher labor and talent costs. The manufacturing industry is relatively more affected by the rising costs of materials and logistics services. Inflation not only affects these prices, but also interest rates and therefore how we assess the cost of our holdings, which is made up of the cost of materials and the opportunity cost of the money tied up in these materials above.
Q: What are companies doing to counter high inflation in their supply chains?
A: The number one lever is pricing, right? Inflation primarily creates a cost-price squeeze. When we conducted our surveys in the middle of this year, we found that pricing was still the most important lever.
Surprisingly, when we conducted our surveys mid-year, about half of the companies said they were able to mostly hold their margins and didn’t see the need to make drastic changes in spending or overhead. But the other half of the respondents stated [they were considering] reorganize to [reduce] their overheads, reducing some discretionary expenses, or potentially looking at their working capital – specifically their inventory.
Q: I realize you’re not an economist, but where do you think inflation is going? Have the actions taken by the Federal Reserve had any impact on controlling inflation?
A: The high prices we are currently experiencing are the result of many supply and demand drivers. Above all, many sectors have been struggling with supply bottlenecks for 18 months due to the very strong demand. So it’s unclear what monetary policy can do other than try to encourage investment in the supply and ensure it’s in place [an opportunity] allowing supply to recover and demand to catch up.
But this is just another area of uncertainty the supply chain is grappling with. We always deal with uncertainties in the volume of demand. Now inflation is raising questions about what the margin will be. So I think this just added another dimension of uncertainty that supply chain planning needs to take into account when conducting scenario analysis and making recommendations on how best to operate in a volatile environment that now has demand uncertainty and some margin involves uncertainty and potential margin squeeze.
Q: Are there specific areas that supply chain planners should focus on in this era of high inflation to contain costs?
A: Certainly. The task of supply chain planning is to find the best balance between supply and demand. So we could consider inflation as just another [complication] We try to navigate while seeking the balance between supply and demand. I don’t know if supply chain planning can be blamed for reducing or controlling costs, or can focus so much on accounting for some of these new price dynamics when trying to find the best balance.
The most obvious thing for supply chain planners to think about are these new economic drivers under their inventory. Not only has the unit cost of inventory increased, but the opportunity cost of holding inventory has also increased due to higher interest rates.
This could prompt them, for example, to reconsider how to balance the pursuit of operational efficiencies with the need to control inventory levels, while also accommodating these new costs. This could result in potentially smaller production volumes and more frequent changeovers, which would seem counterintuitive until you consider that inventory could potentially cost a lot more than it used to.
Q: When designing our supply chains, how much does creating resilience within these supply chains help mitigate some of the effects of inflation?
A: The past few years have taught us a lot about the importance of resilience, both in the way we design our networks and in the way we build our supplier portfolios. What we are dealing with also speaks to the need for agility in the face of all this uncertainty – the need not only to have some agility in the nature of our networks, but also to have agility in the way we make operational decisions . Given the uncertainty surrounding margins and demand over the next few quarters, we need to keep our operational decisions and associated processes flexible and agile enough to revise them as new demand and margin information emerges.
Q: If we enter a recession, will supply chain management strategies be different than if we were trying to contain the inflationary pressures we are feeling now?
A: Well, some might argue that we are already in a recession, depending on how we define recession. But if inflation is affecting margins, the recession is affecting potential demand volume.
Certainly, given the potential for a recession, this means that planners should consider downside demand scenarios and what that might mean for supply planning. You don’t want to commit too much to supplies that could end up being unnecessary and/or expensive relative to market trends.
So I think if we’re worried about a recession, let’s stay agile. We want to manage and moderate how we make future commitments to demand – potentially committing to smaller volumes at any time so we can adjust as new information emerges about the direction of demand.
Editor’s note: This article originally appeared in the November 2022 issue of DC speed.