“We are expecting higher commodity prices next year, so logistics folks should anticipate bulking up on some inventory later this year.” With that statement, Alan Beaulieu, president of ITR Economics (www.itreconomics.com), adds that he realizes managing amidst volatile raw materials costs isn’t as simple as that—especially with China being a major wildcard.
China is embarking on a 2 trillion RMB stimulus program to build more housing, railroads and other transportation infrastructure, which means they’ll be demanding lots of construction materials. And with higher energy prices set to drive the price of plastics, Beaulieu believes that toward the end of the year purchasers will see the rates of change turning around and with the increased activity in Asia they’ll know it’s time to start buying.
“It will seem counterintuitive because prices have been moving down for several quarters,” he adds.
However, building cheaper inventory isn’t the only strategy to lessen the impact of commodities prices on your bottom line. It may be time to revisit your sourcing strategy as well, especially if you source globally.
“Hemispheric sourcing will become very important,” Beaulieu adds. “We’ll find Latin American sources providing more of what we need. The mantra has been for years, and I think more true now than in the past, China plus one plus one: a source from China, one from another part of the region and some other place outside the region. That way you can build a steady supply chain that you can start shifting emphasis on as you need to instead of scrambling at the last minute. People who are sourcing strictly from China will be surprised one day to find competitors that are sourcing from Taiwan, Vietnam and the former Yugoslavia are beating their price.”
Of course corporate priorities may drive sourcing strategies in another direction entirely, even away from “lowest price.” For Scott Brown, environmental sustainability is a major driver in raw material sourcing. He’s president and chief operating officer of Sage Products (www.sageproducts.com), makers of healthcare products for the medical community. It is also one of the largest energy consumers in McHenry County, Ill. Its recent initiative to support green energy by purchasing Renewable Energy Certificates (RECs) for 50 percent of the company’s annual electricity consumption reflects its materials purchasing philosophy as well. RECs are tradable, non-tangible energy commodities in the United States that represent proof that 1 megawatt-hour (MWh) of electricity was generated from an eligible renewable energy resource (renewable electricity).
Sage’s green business philosophy is reflected in its central location which helps reduce energy usage and pollution due to shorter transportation routes. The company sources raw materials from local vendors whenever possible to limit long-distance transportation. Additionally, Sage partners with vendors that share its commitment to sustainability. For example, the company’s third largest vendor supplies cellulose fibers made exclusively with wood pulp harvested from sustainable forest plantations in the United States. Other ongoing initiatives include purchasing corrugate that is made from 30 to 100 percent recycled content for packaging.
In some cases this green philosophy adds cost, but Brown is convinced there’s a payback.
“Doing the right thing is good for your business on the bottom line,” he says.
But doing the right thing also means training all associates in this philosophy as well, and that requires a good eye for nuances.
“You can always buy raw materials that are less expensive than the ones you’re purchasing now, especially if it comes from somebody who’s not selling to you on a regular basis,” he adds. “But what risks are you taking in that purchase and what quality are you giving up? It could be inherent in the material, the service or just in the financial stability of the vendor.”
Brown also tries to discourage the kind of short-range thinking that’s common among purchasing professionals who are given incentives to shop for the lowest price. That may mean finding the courage to spend a significant amount now to save a significant amount down the road.
“If our materials management group has an opportunity on their desk where I have to spend a million dollars to save $2 million, I want that person to run down here, interrupt what I’m doing and say we must have this,” he concludes. “We’ll fast track that kind of opportunity all day long. That might mean spending a million more than we had budgeted for, but in that case a material manager should be commended for that type of thinking.”
Avoid Clashing Incentives
Mike Gray says Sage’s kind of vertical communication is critical to any business, especially when it comes to materials sourcing. As a “Supply Chain Evangelist” and an affiliate at business improvement consultantcy Oliver Wight Americas, Inc. (www.oliverwight-americas.com), Gray regularly speaks at conferences about the need for a meeting of the minds beyond departmental walls—especially on how performance is measured.
“If you’re at the top of the organization make sure you’re not driving conflicting metrics,” he advises. “A procurement person is often measured by what they paid last time vs what they’re paying now and what they project to pay. They’re looking for the lowest cost source and doing everything contrary to what a good logistician might do. They may hear the base material cost is going up so one of their strategies could be to stock up. But because logistics leaned everything out there may not be places to stock up any more.”
That causes tension in the system. An unexpected inflow of cheap materials means logistics people must jump through hoops to move things around quickly. From a cost driver perspective, that’s last thing a logistics person wants to do because, as Gray says, any time you have emergency shipments or quick movement of material it costs more money on the transportation and distribution side.
Your organization must operate as a supply chain both internally and externally. Gray says that’s how Apple is able to purchase four million of something, preposition it and then say it’s available.
“Supply chain hasn’t changed,” he says. “The disciplines of planning, procurement and logistics haven’t changed. What’s happened is we’ve blurred the lines between all of them and forgot to tell our humans to talk to each other.”
Ron Giuntini, business consultant and principal of Giuntini & Co. (www.giuntinicompany.com), says an organization needs to be schooled in risk mitigation so that when managers start seeing volatility in material supplies they can consider these questions:
➤ Should we substitute materials? How would that affect product quality?
➤ Are competitors substituting?
➤ What will substitution do to profit margin?
➤ How much wiggle room is built into the profit margin?
➤ If we start stockpiling how does that affect our demand history and how will it affect future planning?
➤ Should we enter the futures market instead (contracting to pay $1 now for an item you think will go to $1.50 a year from now)?
➤ Does it make sense to source components in-house through 3D printing?
That last question isn’t as futuristic as it seems. Companies are already storing composite materials like sand, metal and glass and using 3D printers that work off of CAD programs to build components layer by layer using these materials.
The answers to these questions must come from the experts in your employ, across all departments, vertically and horizontally—as guided by your company’s business plan.