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Last week, Supply Chain Matters commented on what is turning out to be one of the most troublesome supply chain challenges in 2011, namely the challenge of exploding inbound material costs. This challenge often points to the need for companies to either raise product prices, which could jeopardize momentum of product demand, or undertake further cost reductions to offset material costs increases.  Recent polls of supply chain professionals indicate that volatility of demand and rapidly changing business demand patterns are also a dominant challenge.  If reports of Q4 earnings are an indicator, both challenges are occurring simultaneously in multiple industry sectors, and the proper balancing of both will be the differentiator for those companies that succeed in this ‘new normal’ of business in 2011.

The challenge of rising input costs was specifically noted in both B2C and B2B industry sectors.  Procter and Gamble indicated that higher inbound costs will lower its annual earnings by about $1 billion, noting that commodity prices were 20 percent higher than a year ago.  As a result, P&G initiated a new round of internal cost cutting including the elimination of some manufacturing lines, and has not ruled out selective price increases for certain products.  Kimberly Clark, under pressure in rising commodity costs and also competition from private brands,  plans to sell, close or streamline six manufacturing facilities. Yet, the company admitted it may have cut production too deeply in Q4, giving up an estimated $20 million in profits. Industrials maker 3M is actually building inventories in expectation of continued booming export demand and a robust Q1.

The CFO of Ford Motor Company noted that the company expected to see additional pressure on commodity costs in 2011.  Ford reported that its average profit margin on each of its cars and trucks produced in North America was $1730, while profit margin per vehicle in Asia was a mere $97 on roughly 40% of North America’s output volume.  The implication is that while Asia demand is booming, in a market of high price sensitivity, the challenge to increase margins in the midst of such challenges will be a prime concern.  Meanwhile Volkswagen warned that a shortage of certain electronic components within its engines will force the company to halt production at two German factories this week.  German automakers have experienced extraordinary order rates primarily driven by demand in emerging markets.  The CEO of Daimler noted that suppliers are under quite a strain to keep up with demand, and everyone is struggling.  In December, the Vice President of Procurement for BMW North America noted that some of BMW’s suppliers cut too deeply during the recession, and now cannot keep pace with current demand.  Corning who had slashed inventories during the recession, struggled in 2010 to keep-up with auto maker demands for emission control filters, having to ship parts by air to China factories.

Caterpillar experienced a blowout Q4 due in part to the fact that exploding commodity costs have fueled mining companies to invest in additional equipment, while the increased boom in building and construction in emerging markets fuels the need for additional equipment.  While acknowledging that higher prices for metals and other materials were evident, the company did not see them as a significant challenge in 2011, primarily because of the increased efficiency of its internal manufacturing plants and external suppliers.  Last year, Caterpillar’s internal plants boosted shipments at the fastest rate in more than three decades. However the company has been shifting the sourcing of complex parts away from more costly regions, such as Japan, into China.

While Apple has done an extraordinary job in being able to respond to and sustain explosive shipping volumes for iPhones and iPads, other consumer electronics providers continue to struggle with the combined challenges of select component shortages brought about by explosive demand, and now, the threat of increased material and component costs impacting margins.

These combined challenges have not gone unnoticed, and the financial media and Wall Street have taken notice to both challenges, but in our view, haven’t connected the dots as yet.  Rising raw material and component costs prompt fears for maintaining rather healthy margins and healthy balance sheets.  Wall Street enjoys the benefits of exploding productivity as companies continue to get more done with less.  On the other hand, the visibility to the constraints of today’s extraordinarily lean supply chains continued to be noted. Unplanned or exception events, can cause either a lost opportunity on securing new business, or pay a penalty in increased costs to satisfy demands.

The real victims in 2011 may well be smaller suppliers who are caught in the vise of larger customers demanding additional cost and productivity concessions, or increased agility to respond to exploding growth opportunities in the emerging markets.  These same suppliers are squeezed by challenges to access additional capital financing and to invest in the business process and advanced technology tools that can provide broader supply chain visibility and responsiveness.

The two significant supply chain management challenges in 2011 of offsetting exploding material costs, while insuring the ability to be agile and responsive to more explosive demand coming from certain geographic regions, will no doubt cause some firms additional setbacks.  Cutting more costs internally while demanding a more agile and faster responding supply chain are mutually exclusive and conflicting goals.  This does not bode well for either North American based supply chains or smaller suppliers caught in the current squeeze.

Tough decisions are in store for the remainder of 2011.  Organizations that most need to invest in value-chain agility and responsiveness may find themselves prohibited from doing so by cost pressures.  The need for closer communication and coordinated strategy among procurement and broader supply chain management teams will be a fundamental challenge in 2011.

How is your organization addressing these two challenges?

Bob Ferrari

© Copyright 2011 The Ferrari Consulting and Research Group LLC