Recession, Deflation: What is it to Supply Chains?

Here are some of the signs of our times.

  • Recession, we knew it all along except that now it is official!
  • Deflation, the stories are everywhere even though they don’t add up. See this article for more information, though let us assume some deflationary pressures may actually exist and continue for some time.
  • Credit crunch, less said the better. This is probably the root cause of major financial failures for many a companies. Fed is throwing reams of dollars at the problem but it is still out there threatening businesses, large and small that need debt for short term and long term obligations.

What does this mean to retailers? Pretty much the same thing, as all of the above conditions result into low demand for goods and services, pressure on pricing power, and tight credit for consumers as well as retailers. This adds up to the following net results.

  • Top line impact. Low top line growth as consumers cut their spending due to recessionary pressures, job losses, uncertain financial conditions and tight consumer credit. All of these will result into low to no top line growth, and in some cases it may very well shrink.
  • Bottom line impact. Low profitability, fueled by increased competition, too little demand, too little disposable income that all adds up to pressure on cutting prices further to retain the sales, and hurts the bottom line.
  • COGS impact. Higher cost of operations, driven by the tight credit and higher cost of money when it is available. Add to that the volatility of demand, and the desire to maintain good inventory levels to service customers when they do step in and buy.

So what is a retailer to do?

There really are not many options. In good times, you could follow a top line growth strategy effectively, but when the sales tank due to depressed consumer demand, there is only one strategy that works: laser sharp focus on the Cost and Efficiency. For the financially inclined, COGS and Asset Turnover.

A good supply chain strategy can deliver on both these fronts.

In fact, supply chains are all about costs and efficiency. Anything you do better in your supply chain management is bound to affect either of the two. Take for example, inventory planning processes. If enhancements to this process results in lower inventory, your inventory turnover goes up affecting the Asset Turnover positively. Assuming that the process improvements result in better fulfillment but do not affect inventory levels, the cost of operations for fulfillment and cost of lost sales goes down through better inventory deployment. Either way you come out ahead. Take transportation optimization, you reduce the miles, and have a direct impact on cost of transportation and hence COGS. Take forecasting improvements to have higher accuracy, and once again you save the cost of lost sales through better planning and deployment of inventories.

In fact any supply chain process improvement whether it is in planning or execution, network design or supply planning, demand planning or warehousing; all lead to either direct cost savings affecting the COGS, or more efficient use of assets affecting the Asset Turnover.

The next question of course is which is more important? Cost or Efficiency? Well that really depends!

It depends on what does the retailer want to achieve? If the retailer has good operating cash flow (and hence no need to borrow funds from the market), your efforts should be more focused on direct cost savings that will translate into the bottom line gains. If operating cash flow is an issue; and, it is if your survival depends on it, then profitability is a secondary consideration, and efficient use of resources may make more sense specially in a market where credit is either not available or the cost of servicing credit is simply unacceptable.

Rather than closing all initiatives, corporations should analyze and understand the impact of each current supply chain initiative. Then they should re-prioritize using the analysis, and their current needs. For reprioritization, follow the steps below.

  • List all your current supply chain initiatives. Note where in their deployment life-cycle these initiatives are, what are the sunk costs, and what are the estimated costs to finish them?
  • Classify these initiatives into those affecting Costs, and those affecting Efficiency.
  • For those affecting costs, determine the impact on COGS; for those impacting efficiency, determine the impact on Asset Turnover.
  • Establish the immediate organizational priority between Costs & Efficiency.
  • Re-prioritize the current initiatives based on the above information.

 

Deflation: Should you Worry?

If you have tuned into the news during the last few days, you must have heard the coverage on deflation, and how spiraling deflation is getting out of control. But if the prices are really falling, it never felt like that at the grocery store, or at the departmental store, or toy store, or at the dentist. So why are the analysts worried sick? I believe they are trying to find news where none exists — as yet.

While deflation may be a definite economic evil, the numbers so far do not add up to the extremes pointed out by the mainstream media or the analysts. But then, you could not blame them really — an inflation report within normal limits won’t make the news, would it?

Let us go to the source, and look at some numbers provided by the Bureau of Labor Statistics.

Here is the graph for Consumer Price Index – All Urban Consumers, Not Seasonally Adjusted, available at http://data.bls.gov/PDQ/servlet/SurveyOutputServlet?data_tool=latest_numbers&series_id=CUUR0000SA0&output_view=pct_1mth.

CPI, All Urban Consumers, Not Seasonally Adjusted, for ALL ITEMS

The graph above shows data for ALL ITEMS. And that is a key difference because when you exclude the prices of food and energy, the prices actually rose as seen the picture below. This is available at http://data.bls.gov/PDQ/servlet/SurveyOutputServlet?data_tool=latest_numbers&series_id=CUUR0000SA0L1E&output_view=pct_1mth. Now we have all seen the prices at the gas pump fall dramatically after their equally dramatic and unexplained rise in summer this year, and that is a big part of the deflationary data being touted as a real concern.

 CPI, All Urban Consumers, Not Seasonally Adjusted, for Excluding Food and Gas

Again, if the prices are really falling, why are we not feeling any reprieve? Because year over year inflation is UP, by 3.7% even when you include the recent big drops in gas prices, (http://data.bls.gov/PDQ/servlet/SurveyOutputServlet?data_tool=latest_numbers&series_id=CUUR0000SA0&output_view=pct_12mths). See below.

CPI - All Urban Consumers, 12 Months Percent Change for ALL ITEMS

Here is a break-up of inflation numbers, and these are really helpful in understanding where the problem lies, rather than painting a broad-brush picture of impending doom due to deflation. All numbers are available at: http://www.bls.gov/news.release/cpi.t07.htm. The numbers below are for based on chained Consumer Price Index for All Urban Consumers (C-CPI-U): U.S. city average, by expenditure category and commodity and service group, with December 1999=100.

Expenditure category Unadjusted Relative Unadjusted percent change to importance, indexes Oct. 2008 from-Oct, 2007 Unadjusted Relative Unadjusted percent change to importance, indexes Oct. 2008 from-Sept, 2008
All Items

3.3

-0.8

Food & Beverages

5.9

0.5

Housing

3.0

-0.3

Apparel

0.1

1.0

Transportation (read: Cars and autos)

3.6

-4.5

Medical Care

2.7

0.2

Recreation

1.1

0.0

Education & Communication

2.7

0.1

Other goods and services

3.9

0.3

Energy (read: Gas)

11.4

-9.8

There you see the two categories that are causing the biggest deflationary pressures, cost of energy (we know gas is down), and cost of transportation (cars and autos). Neither of them is exactly news, sales of big ticket items is down, and is expected to be slower with the continuing credit crunch.

Should you worry? Decide for yourselves!