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Five ways to use the current crisis to improve supply chain management

Corporate leaders can use the current supply chain crisis to reimagine their future supply chain.

In brief

  • Supply chains are in severe disarray. Supply chain leaders need to not only solve today’s issues but build a stronger supply chain for the future.
  • Segmenting products based on value and risk can inform decisions on what items to prioritize and what SKUs may even be discontinued.

The abrupt and severe supply chain crisis has sent companies scrambling to access raw materials and labor they need to manufacture goods and transportation capacity to ship products. Compounding the issue are erratic spikes in demand and inflated material and transportation costs. Many companies are making expensive short-term decisions that may have long-term repercussions and can even lengthen the crisis.

Strategic-minded manufacturing and retail leaders can use the crisis to reimagine their supply chain management over the long term.

Key supply chain issues

There are a number of drivers for these supply chain and customer service-related issues, some of which are interrelated:

  • Demand spikes caused by pent-up consumer demand due to COVID-19 restrictions and government stimulus is giving consumers more spending power and changing the way they buy.
  • Raw material or component shortages, which have been exacerbated by the pandemic but were also triggered by global trade issues and commodity price spikes.
  • Labor shortages, which may be a sign of a fundamental change in labor participation set off by the pandemic. Work safety protocols, vaccination requirements and flexible work locations are just a few of the factors that are affecting the labor market.
  • Manufacturing capacity shortages caused by labor shortages, disrupted global fulfillment and rapidly shifting consumer demand.
  • Transportation issues caused by a massive backup at US ports and a shortage of truck drivers that began before the pandemic and has been exacerbated by surging demand and truck drivers retiring. According to the American Trucking Association, the industry is short 80,000 truck drivers, up from a deficit of 65,000 before the pandemic.

The resulting shortage of materials and finished goods and increased costs can lead to negative customer experiences and reputational damage. For example, the inventory-to-sales ratio, an often-cited measure of supply chain agility, has fallen by more than 11% since February 2020, according to the US Census Bureau, and has reached its lowest level in more than nine years. But this metric can be misleading. The common response to perceived shortages is to overstock inventory, but this only exacerbates the problem by sending false demand signals through the supply chain, resulting in serious financial consequences in the long term.

Figure A shows how companies can identify and address supply chain issues.


How EY can help

Segmentation as the first step in responding to the supply chain crisis

Differentially prioritizing key products should form the basis for decision-making, both downstream and upstream in the supply chain. In order to differentiate key products, companies should design and develop a model that takes into account both risk and value, as well as cross-functional stakeholder feedback.

 

For example, one leading med tech company has had to adapt to semiconductor shortages. It segmented its products into “must-haves” vs. “deferred production.” This helped it then decide to reach out to new sources including contract manufacturers that were sitting on certain components as their own customers were “line down” and did not want to sit on the inventory. This allowed the med tech company to find components for its “must-have” products.

 

The segmentation model (see figure B) should incorporate financial, commercial and operational parameters such as margin, profitability, service levels, capacity, demand variability, and lead time. This can provide a holistic and integrated view of how products can be prioritized. The segmentation model output should flow through to the procurement plan, the production schedule and customer service order allocation rules and decisions, with a focus on maximizing throughput for resource-constrained, prioritized items. Put simply — allocate resources in short supply to the production and shipment of high-value products to high-priority customers.

 

In the longer term, the model can also help companies phase out lower-value SKUs that may have proliferated in better times.

 

Figure B: Product segmentation framework


Five steps to build tomorrow’s supply chain

1. Collaborate with customers.

While forecasting technology and analytics are crucial to successful customer service, communicating and partnering with customers “beyond data” is one of the best ways to understand their requirements and needs. It is crucial to understand customers’ service priorities. Additionally, it is important to understand the extent to which changes in customer demand mix and channel are transitory or a “paradigm shift” going forward. These insights and other intelligence should then be incorporated into the integrated business planning (IBP), capacity planning and capital planning processes as well as the product segmentation model.

2. Leverage data and technology to respond and predict.

Develop and implement a bespoke analytics infrastructure where appropriate to support “war room” development and execution of the product segmentation model and the prioritized procurement, production and service plans — integrating both quantitative and qualitative stakeholder and customer input. Leverage information from customers to “re-baseline” historical data in segmentation and other analyses to reflect known and forecasted demand requirements. In the longer term, a strong data management and forecasting platform is essential to get ahead of demand shocks. Being able to sense changes in demand patterns is crucial, particularly if supply chains are “long” and dependent on many upstream processes. Invest in “best-of-breed” analytical and planning systems with robust scenario-modeling capabilities to respond to supply chain crises predictively and dynamically.

3. Embrace additional views of performance measurement and tie to the operating model.

Move beyond more traditional performance metrics such as piece price and cost per unit and focus on minimizing constraints and increasing throughput of high-priority items. Companies should leverage product segmentation to determine where short-term input price and manufacturing cost increases to reduce constraints and improve customer service are appropriate; in some cases, customer prices can be increased to enhance incremental value. These price increases are already happening among some high-demand consumer products, as well as in autos, energy and many other sectors. These decisions should be incorporated into the existing sales and operations planning IBP processes.

4. Secure resources for core products while enabling an agile delivery model.

Evaluate short-term opportunities to secure access to capacity, raw materials and labor pools. Critical raw materials and components should be procured from alternative supply sources and/or at lower lead times (and at a higher piece price), if necessary. This may cause margin and working capital performance erosion in the short term but is necessary to limit supply chain disruption. Additionally, companies may need to secure additional transportation and warehouse capacity, including expanding operations in off hours. In the longer term, procurement and planning strategies should help drive a more resilient and agile supply chain through strategic inventory buffers, multi-sourcing and “upside” capacity arrangements; expanding strategic contract manufacturing and third-party logistics (3PL) relationships can enable companies to adjust capacity and throughput in response to changes in business requirements.

5. Prioritize training and development.

Labor constraints are a major factor in the supply chain crisis. In the near term, companies should expand training within the existing labor pool to reflect product prioritization. In the longer term, training should focus on flexibility through cross-training in order to be most responsive to customers. Increasing incentives for cross-training and skills development can help motivate employees to train in new capabilities. Additionally, managed services can provide staffing flexibility.

Mark Tennant and Daniel Gravelle of Ernst & Young LLP contributed to this article

Summary

The supply chain crisis will not be solved immediately. But companies can mitigate the pain and prioritize their key products and customers. At the same time, a crisis can spark change going forward, building long-term resiliency into the supply chain.

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