Supply Chain Levers in Inflationary Times: Managing Cost and Cash Flow
by Ryan Burns
To say that markets have been dynamic in the past three years might be a bit of an understatement. There has been dramatic inflationary activity in many commodity markets (metals, freight, polymers, labor, the list could go on and on.) As a result, most manufacturers have seen increases in their costs, especially concerning direct materials. Combined with interest rates continuing to increase, it has led to a much greater focus on all costs and on how working capital is used, especially regarding inventory. There are many levers you can use to influence cost and cash flow, but here are some supply chain ones you can pull.
When people think of supply chain, procurement is often the first part that comes to mind. Every manufacturer must buy something to support their business. Your buyers are your first line of defense when it comes to pricing. There are a few key things that you can do to manage costs more effectively with respect to pricing.
- Just say no
It may seem trite, but the easiest way to avoid an increase in price is to say “no.” You’d be surprised how often this works. Many customer-facing employees are given some degree of latitude on pricing. It might save you some of the increase, it might push the increase to the next round, it might just prevent it indefinitely. And sometimes, it just doesn’t work. But anyone who is allowed to engage with suppliers from your organization should understand this first step. The next step would be to follow any processes you have in place to alert others in the organization to a price increase; even if it is mitigated at present, the team may need to be aware. I always suggest basing your policies with respect to price increases on annual impact. A 70% price increase on a $100 item that is a one-off buy may not even warrant discussion; a 1% increase on a high-moving item might change your profitability targets.
- What goes up must come down (sometimes)
Suppliers are usually very good at coming to their customer base when inflation drives up their costs – I’m sure you’ve seen this multiple times in the past few years. They don’t, however, seem to reach out when the market drops, so you need to ensure that you are following markets and cost increases. If you must take an increase, ask questions: what index is this based on? What percentage of your inputs are affected by this? Even if they won’t or can’t answer, let them know you’re paying attention. You can at least use their increase in price and known market changes since their last price change to put an estimate on the calculation – use that when markets drop.
- Stop it before it starts
If possible, start to manage this on a forward-looking basis by including when and how costs are adjusted in your contracts. I would also suggest that as you do build market-based price changes into your contracts, try to measure changes over a longer period of time. For example, use the market price average over the past 3 months. This will help to mute large market swings and help you to manage your costs better quarter to quarter. Try to find an agreeable “no-fly zone”; an amount of change from your last agreed change in price that does not cause action. Sometimes they win a bit, sometimes you win a bit, but both of you save a lot of time and effort on the administrative side. Try to avoid spot-pricing any way you can.
Supply chain has two major ways to influence cash flow: inventory and payables.
- Are your inventory levels based on your current reality?
Everyone knows that less is better when it comes to inventory – as long as that “less” can fully support your needs. Slightly better inventory turns will likely never make up for lost sales, late penalties, etc. That said, your inventory strategy needs to be reevaluated at least every six months, preferably every 3 months or more based on the changes in your business and supply chain. Make sure that your inventory levels reflect your current situation – the current supplier performance (have lead times changed?), the current cost (was your purchase quantity based on a pricing level that has changed?), the current needs (has your usage changed markedly?), and your overall strategy (does this still match my business strategy?) And the most important question of all is “Are the right people making my inventory decisions?” There are many times when inventory levels are set and never addressed again, e.g., “Sales asked to add a safety stock of 50 to this part 2 years ago” or “We set the minimum order quantity to 8, but I can’t remember why”. These questions become even more important as rising interest rates make cash even more important.
- Think about the form of inventory, not just quantity
When you think about inventory strategy, it’s just as important to think about the form of inventory as quantity. If you currently stock finished goods, could you stock partially assembled product instead? Or have you improved throughput and can meet customer lead times without stocking finished goods? Think through all the reasons you chose the current form of inventory and make sure that those driving factors are still relevant today. These kinds of changes can make big differences in your inventory – even if you still have a similar amount of material on hand, moving it to raw or WIP would make a big difference in total value.
- Does my inventory strategy match my commercial strategy?
In all decisions, inventory strategy included, whether it is a good match for your commercial strategy is key. There are too many to mention here as there are so many ways to position a business. But ask yourself: What benefits am I giving my customer? Which are they willing to pay for (and which do they require to even consider me as a supplier)? Are my purchases in line with my orders with respect to timeline? What changes could I make to my inventory strategy that would have little or no impact to my customers? Do I have contractual commitments on inventory levels, and if yes, do those still make sense and am I getting the expected commercial benefit from doing so?
- Are my payment terms market-competitive?
When it comes to payment terms, they can put many small- to mid-sized manufacturers in a crunch. Large customers require extended terms, but large suppliers aren’t willing to extend those same terms to you due to your size. So, focus where you can – see if your terms are market competitive; if not, address it with your suppliers. Try to extend them even by a few days. If you’re trying to move them drastically, offer a stairstep approach so the supplier can better manage cash flows.
- A credit card may be a better option, if available
Some suppliers may not budge on payment terms. If they take credit cards, that may be a way around it. The average time from charge to payment is just under 45 days – so if you have terms less than that, a credit card (P Card) would be a good way to manage those. But pay attention – if they pass along any processing charges, that likely negates the extended terms. And if the goods in question are direct materials, ensure that you still place purchase orders in your system to match against for your records. Management of the card and limits are extremely important too – the potential for misuse is higher with credit cards as vendor approvals and other checks and balances you have with a purchase order aren’t required. Be sure to educate any user that all processes and procedures are the same, and make sure you are checking the statement monthly to match all purchases.
- Another option in receivables
Okay, this isn’t payables or supply chain but well worth mentioning. Some of those large customers that require extended terms may also offer supply chain financing. I won’t include all the details here but see if any of your customers offer it and run the numbers. Many folks assume that any offer from a large corporate customer is not favorable for you – this usually isn’t the case with supply chain financing. It can allow you to shorten the time for your receivables on demand for a small fee. But you’ll typically find this is a better rate for your business than other options like a line of credit for managing cash flows.
Each business is different, each one is going to benefit from the strategies and tactics that best match their current needs. But your needs change over time and you need to ensure that your strategies and the processes and policies that strategy dictates change as needed too.