Companies are always challenged to adapt their supply chain to market developments. During boom periods, companies are eager to match production capacity to growing demand. No one took recession into account. Until 2008.
During the financial crisis that started five years ago, causing an unforeseen drop in demand across numerous industries, this challenged supply chains more than ever. The processing industry in particular suffered serious blows as a result of the recession. Sectors such as mechanical engineering, metal industry and transport saw their customer orders drop by up to 42%. The uniqueness of this crisis is that it is global, threatening entire supply chains to collapse.
Supply Chain Actions in difficult times
Control measures in difficult times are known and are generally in accordance with the classic turnaround approach. These actions include significant cost reductions (including overhead costs), the introduction of zero-based budgets, the setting up of war rooms, and redefining networks. However, it is critical to understand the trade-offs between temporary and sustainable actions. In addition, it is important to plan for the inevitable and prepare the supply chain for structurally difficult times.
When a medium-sized automotive supplier in Southern Germany was confronted with a significant drop in demand, the company reacts quickly. A production facility was closed, production volumes were shifted to low-wage countries. Many experienced employees disappeared in their own country. As a result, the specific knowledge required to run new production lines optimally was not transferred properly in the new production location.
Productivity declined despite a Lean manufacturering program, which caused the company’s cash position to decline sharply due to restructuring costs, declining gross margin [production] and declining net margin due to market price declines. The company struggled to be saved from bankruptcy.
To prevent such situations, there are a number of things that are essential and run parallel to each other.
- Insight into the actual question.
- Control and protection of Supply chain
- Creating Flexible, Breathing Supply Chains
- Align Stocks to Free Up Money.
- Preparing the Up-Swing
Insight into actual demand
An important lesson from the financial crisis was that many companies have underestimated the seriousness of the fall in demand. Since demand forecasting is the starting point of all planning (i.e., capacity planning, supply planning and production planning), it is crucial to understand the real demand.
Identify actual demand.
For most companies, the visibility of real customer demand was particularly low. This was caused by a certain degree of sales security. With an economic boom, buying and willingness to sell is significantly better. Only during a recession, when a sharp choice is made, will the real question be exposed. Then it also becomes clear that Sales is too much driven by budgets and the opportunistic nature of this comes to the fore.
Communicate with customers regularly.
Many companies put more emphasis on the short-term prospects in their communication with customers. Procurement departments themselves often had no insight into the volumes of orders in the coming weeks and months and lack insight into medium-term trends.
Draw up multiple question scenarios.
Due to the limited visibility, a prediction for a product line is often difficult to obtain. Drawing up scenarios can improve insight into possible sales developments. Such scenarios take into account questions such as:
Worse case scenario: what if sales decrease by 80 percent?
What would be the result if all our factories in France closed for three months?
What are the total stocks of all European customers, and what would our business partners need to dispose of all their stocks?
Given the current order book and the lack of new demand, how long can we keep our employees?
Control and Protection of Supply
The unexpected and seriousness of the recession forced many companies to the brink of bankruptcy. While sales and demand hit an all-time low, sourcing departments faced an entirely new challenge. The risk of losing the suppliers and thus the stability of the supply chain.
This is therefore about risk management of your supply chain on the sourcing side. Three elements are essential in this. Identifying supplier criticality, controlling suppliers’ financial health and delivery times and ensuring the survival of your critical suppliers.
Although most companies have established a regular risk analysis and management process, these processes usually focus on physical supply chain disruptions such as natural disasters or strikes. The risk of losing the suppliers next door is often neglected. Therefore, supplier criticality should be revalued based on the risk of supplier insolvency. Which critical parts and how much volume do we have from a supplier? Which alternative suppliers are certified? What volumes can these alternative suppliers offer?
Financial health suppliers.
Various types of sources of information can be used, such as information from buyers about the speed with which suppliers place and confirm orders or requesting previous payments, information from company visits and information from media about, for example, sell-and-lease-back deals or the loss of important people to understand the “real” situation of the supplier. In addition, the quarterly audit of the suppliers’ financial statements.
In addition to financial health, delivery times must also be carefully monitored. Especially with an economic turnaround. With low order flows, suppliers quickly struggle with the utilization rate of their machine fleet, which means they stretch delivery times.
Creating flexible Supply Chain
As demand collapsed, companies immediately struggled with their overcapacity and struggled with the scale of their business in the short term. These challenges are often inevitable because the network design and strategic decisions were carefully tuned for a very specific demand and growth scenario
Businesses should therefore take proactive demand uncertainty into account and design supply chains that can handle broad demand. By breathing we mean supply chains that can switch more easily between different growth and shrinkage scenarios. This is also a good tool for fluctuations in more regular operations. This includes: Understanding the effects of fluctuations in demand, converting fixed costs into variable costs and defining smart contracts.
Understand the effects of fluctuating demand.
An important task in defining supply chains is to adapt capacity to demand. Therefore, it is crucial to get a good understanding of the effects of fluctuations in demand. Companies need to determine what actions to take based on the particular demand scenarios. This should be part of the supply chain strategy.
Convert the fixed costs into variable costs.
Ultimately, it is critical to convert fixed costs into variable costs to offset lower production with diminishing marginal yield. Companies often have closed or “dormant” assets with lower productivity. Thus, an alternative to reducing fixed costs involves increasing the use of “fixed” assets and labor through, for example, insourcing. In addition, the incremental costs must be carefully analyzed when moving production to other factories.
Define smart contracts.
The definition of smart contracts with suppliers plays a critical role in creating breathing supply chains. Many companies have long-term contracts with suppliers to take advantage of discounts. However, once imprisoned, people often become completely dependent on the good will of the suppliers.
Optimize stocks to free up capital
Reducing inventories that meet specific service levels has always been a major challenge for the supply chain manager. However, the limited availability of credit during the financial crisis led to skyrocketing interest rates for stock optimization, so companies needed a fairly significant amount of cash in the short term. In an earlier blog, I described the ten most important points for keeping your stock optimal.
Preparing the Up-Swing
While many companies are still struggling with the crisis and still adjusting their supply chain, many other companies are already looking to the future. These companies focus on the following matters: Retaining and developing talent, long-term projects and head capacity.
Develop retention and talent.
While the length of the crisis was unclear to most companies, many companies realized the importance of retaining and developing talent throughout the recession. As manufacturing processes have become more complex in many countries in recent decades, it is important to retain expertise.
Long term projects.
Many companies realized that the economic downturn can also be seen as an opportunity to prepare long-term initiatives, as long as no major investments need to be made immediately. During the boom, companies often grow so fast that the structure of the complex supply chain often leaves much to be desired. Delivery is more important than optimization. The economic crisis is forcing companies to reconsider and giving engineers time to optimally organize the chain. Supply chain towers are now fully organized because of the structural cost savings it provides.
With a sharp downturn in demand, many companies are not equipped to headline capacity. [Sudden increases in demand] Although suppliers often keep capacity on standby for these types of scenarios, many companies are surprised and found to have too much labor and assets cut away. As a result, temporary workers are often hired back to absorb the temporary surge in demand.
Many companies have succumbed to the crisis because they did not have the capacity to adjust their supply chain in time. They also lost critical suppliers and could no longer meet customer demand. These companies often turned out to have high inventory levels, invest little in top talent and focused too much on realizing too high sales forecasts. Many bankruptcies could be avoided if companies had lived less on a pink cloud.
First, companies must be constantly prepared for major changes in their specific market or in the general economic climate. Managers must ensure transparency of demand, early warning mechanisms created using internal and external data, and share it with other company functions, as well as with suppliers and customers.
Eternal growth does not exist
In addition, companies must constantly challenge themselves and test their skills in order to adapt to major changes in supply and demand. A valuable tool is an agility supply chain assessment to determine whether a company is truly prepared for an inevitable downturn. This should be part of a company’s risk management.
More than ever, companies need to be flexible and prepared for the dynamics of the market. Eternal growth, as thought for years, simply does not exist. Even though we are now emerging from the recession, the next one is already in the works. Be prepared. Take control of inventory, supply chain flexibility, develop and retain your talent and be critical of budgets and forecasts. Make sure you know your processes, market, supply chain and your customers and suppliers.