Our supply chains were already under stress. The last thing we needed was for inflation to come along and muddy the waters.
After years of runaway inflation during the 1970s and ’80s, the world’s major economies had done a good job of holding it in check in recent years. But all that progress seemed to evaporate following a period of pandemic-fueled consumer spending and disrupted supply chains. Now, we see inflation rising despite regulators’ best attempts to rein it in.
What can supply chain managers do to ease the effects of high inflation? To find out, David Maloney—the group editorial director of Supply Chain Quarterly's sister publication DC Velocity—recently spoke to Paul Lord for an episode of the "Logistics Matters" podcast. Lord is senior director of research and an analyst with consulting firm Gartner’s Supply Chain practice. He regularly provides research insights, advice, and thought leadership to clients on 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 rates of inflation in decades. How has that affected our supply chains? I imagine there’s more to it than just raising costs.
A: You are right that there’s more to it than that. But certainly, the primary result of inflation has been higher costs across a whole range of resources. It’s impacting labor, energy, materials, and logistics services, so it is really across the board, and, of course, every business is affected in different ways depending on its use of these resources.
For example, service-intensive industries are much more impacted by the higher cost of labor and talent. Manufacturing industries are more impacted on a relative basis by the rising costs of materials and logistics services. Not only does inflation impact these prices, but it also has an impact on interest rates and, therefore, on how we view the cost of our inventory, which is a combination of the cost of the materials and the opportunity cost of the money that’s tied up in those materials.
Q: What are companies doing to address high inflation in their supply chains?
A: The number one lever is pricing, right? Inflation primarily creates a margin squeeze. So, as we conducted our surveys through the middle of this year, we found that pricing was still the top lever.
Surprisingly, as we took our surveys in the middle of the year, about half of companies indicated that for the most part, they were able to maintain their margins and didn’t foresee the need to make drastic changes in spending or overhead. But the other half of those surveyed did indicate [they were considering] reorganizing to [reduce] their overhead spend, cutting back on some discretionary spending 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 measures taken by the Federal Reserve had any impact on controlling inflation?
A: The high prices that we are currently experiencing are a result of a lot of supply and demand drivers. Most notably, many industries have been dealing with shortages in supply for the last 18 months as a result of very strong demand. So, it’s unclear what monetary policy can do other than try to encourage investment in supply and make sure that there’s [an opportunity] for supply to recover and catch up with demand.
But this is just one more area of uncertainty that supply chain deals with. We are always dealing with uncertainty in demand volume. Now, inflation brings in questions around what the margin is going to be. So, I think what this has done is to just add one more dimension of uncertainty that supply chain planning must take into account as it does scenario analysis and makes recommendations for how best to operate in a volatile environment that now includes demand uncertainty, some margin uncertainty, and potential margin squeeze.
Q: Are there particular areas where supply chain planners should focus their efforts to contain costs during this period of high inflation?
A: Certainly. The role of supply chain planning is to find the best balance between supply and demand. So, we could think about inflation as just another [complication] we’re trying to navigate as we seek that balance between supply and demand. I don’t know that supply chain planning can be held accountable for or focus on reducing or controlling costs as much as taking some of these new pricing dynamics into account as they try to find the best balance.
The most obvious thing for supply chain planners to be thinking about is these new economic drivers underneath their inventory. Not only have unit costs of inventory gone up, but the opportunity cost of carrying inventory has also gone up as a result of higher interest rates.
This might cause them to rethink, for example, how they balance the drive for operating efficiency with the need to control inventory levels while taking these new costs into account. This could lead to potentially smaller production quantities and more frequent changeovers, which would seem counterintuitive until you consider that inventory potentially costs a lot more than it used to.
Q: In designing our supply chains, how much does creating resiliency within those supply chains help to mitigate some of the effects of inflation?
A: The last couple of years have taught us a lot about the importance of resiliency, both in the way we design our networks and the way we construct our supplier portfolios. What we are dealing with also speaks to the need for agility given all this uncertainty—the need to not only have some agility in the nature of our networks but also agility in the way we make operating decisions. Given the uncertainty of the next couple of quarters with regard to both margins and demand, we need to keep our operating decisions and the associated processes flexible and agile enough to re-correct as new information about demand and margins emerges.
Q: If we do fall into a recession, are the strategies for managing supply chains any different from what they would be if we were trying to curb the inflationary pressures we are feeling now?
A: Well, some might claim that we are already in a recession, depending on how we define “recession.” But if inflation impacts margins, recession impacts demand volume’s potential.
With the potential for recession, it certainly means that planning professionals should be looking at downside scenarios for demand and thinking about what this could mean in terms of how they’re going to plan supply. They don’t want to get overcommitted to supply that could end up being unneeded and/or expensive relative to where the market might be heading.
So, I think if we’re concerned about recession, we want to remain agile. We want to manage and moderate how we make future commitments around demand—and potentially commit to smaller quantities at any given time so that we can adjust as new information emerges about the direction in which demand is heading.
Editor's Note: This article originally appeared in the November 2022 issue of DC Velocity.
