Supply chain procurement and operational professionals have yet another cost reduction and control challenge to address for the remainder of 2010 and 2011. Many are probably already acutely aware that a spike of key commodity prices is now putting increased pressure on profit margins. The challenge over the coming months will be finding means to offset higher inbound material costs, and it will not be easy.
As the calender winds down the September ending earnings reporting phase, many manufacturing and consumer oriented companies are flashing warnings to Wall Street. The latest, Procter and Gamble, experienced a 6.8% earnings decline and vowed to hold the line on increased prices by offsetting cost reductions. P&G acknowledged that sharply higher costs for paper, pulp and plastic resins are affecting margins. Overall gross margin fell nearly a percentage point to 51.8%. Other consumer goods manufacturers are also noted these new cost challenges. The Hershey Company acknowledged higher inbound costs for cocoa and sugar, but indicated that it will attempt to hold the line on cost increases through offsetting cost reductions. Kraft Foods indicated that it consider select price increases as an offset to higher supply costs.
In the industrial sector, a recent Wall Street Journal article (paid subscription may be required) noted that major industrial suppliers such as Parker Hannifin Corp. and A.O. Smith are all signaling caution relative to reduced margins, and in some cases, reduced growth. However, Illinois Tool Works, who has 800 businesses ranging from appliances to fasteners, that span many tiers of discrete manufacturing supply chains, experienced a revenue increase of 12% and a profit gain of 39% in the past quarter. One could speculate whether such gains were a result of riding the wave of price increases.
The causes of these new cost headwinds are, in my view, twofold. First, they reflect that the spike in inventory buildup that occurred earlier this year emboldened commodity providers or market influencers, such as hedge funds, to initiate waves of price increases to fatten-up their own margins and profitability. One can ponder whether such increases were actually pegged to overall global demand needs.
The other relates to legitimate supply shortages brought about by natural or political events. As an example, wheat crop failures in key agricultural areas, such as Russia, have driven up the price of wheat, and other crop failures in sugar cane or cocoa also triggered natural supply vs. demand price actions. China’s recent political dispute with Japan caused a ban on shipments of rare earth minerals.
Through my lens, this evolving crisis of increased commodity prices is equivalent to gaming the system. Legitimate interruptions in supply have caused increased pricing pressures, but also cause speculation from a new breed of market influencers or manipulators.
For supply chain procurement and operations professionals, it adds a significant additional challenge in the coming months. Many supply chains currently operate in a fragile and lean state. Supply Chain Matters has  penned multiple commentaries noting key parts shortages impacting shipment and revenue results for those industries experiencing robust growth, and our recent newsletter notes the specific impact on various industry supply chains. Additional pressures for cost reductions could risk cutting into the muscle of supply chain capabilities at a time when agility and flexibility to changing business requirements places emphasis on the ability to quickly respond to market uptakes.
The open question is whether this new challenge of inbound supply cost increases without offsetting revenue increases, placing supply chains into a more fragile state than they already are.
Has senior management raised too much of a risk for cost reduction burden on supply chain teams? Will this result in further cross-functional team conflict, and further parts and upside capacity shortages when revenue growth is required?
Only time will tell.
What’s your view? Has the cost reduction challenge introduced significant added risk to supply chain responsiveness?
Bob Ferrari
