Buyers Beware!

With economic uncertainty shaking the foundation of the global supply chain, a tactical response is only natural. But buyers still need to think strategically about their sourcing decisions to ensure long-term results.

The current financial crisis is enough to keep anyone awake at night. Every day another huge company announces yet another layoff that's usually even bigger than the last. Those once thought impervious to even the most trying of economic times have been forced to make sweeping cuts across their organizations. Countless plants, many open for decades, are closing their doors forever.

There doesn't seem to be an end in sight. Manufacturers are still watching helplessly as companies they have worked alongside for years and depended on to supply the quality parts, components and raw materials they need to build their products are also forced to close their doors, seemingly to be erased from existence.

Not surprisingly, one of the biggest challenges currently facing manufacturers is determining which of their suppliers will come out of the economic crisis still viable. "Because of the current financial situation, many suppliers that organizations are sourcing from are going out of business," says Ken Koenemann, value chain practice leader with TBM Consulting Group Inc. "Obviously that is creating some very difficult times."

Next to the banks and homebuilders, automakers have probably received the most publicity for their troubles, with two of Detroit's Big 3 recently accepting $14 billion in bailout funding from the government. But up until recently, the effect on their suppliers had remained relatively quiet. That changed in February when they took a cue from their customers and asked the U.S. Treasury for assistance of their own. Various amounts have been rumored, but at press time nothing had been confirmed.

The request did, however, provide an eye-opening look at the health of the U.S. supply base, acknowledging the more than 40 major auto suppliers that filed for Chapter 11 restructuring in 2008. It went on to note that approximately one-third of all suppliers were in "imminent financial distress," while another third indicated they would be in distress by the first quarter of 2009. Without financial assistance, it concluded that significant supply chain disruptions were practically inevitable.

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"Without appropriate action, automotive suppliers will be unable to return to required operations without shuttering facilities or closing entire companies," said Bob McKenna, president of the Motor & Equipment Manufacturers Association, which represents some 400 automotive suppliers. "This would devastate the domestic auto industry and deepen the economic crisis."

The State of the Supply Chain

Of course, the auto industry is just one example of the many with question marks surrounding their supply chains. The economic turbulence of the past several months has left buyers in almost every industry in a state of perpetual uncertainty. Countless manufacturers have already been forced to undergo significant changes as suppliers have either filed for Chapter 11 or gone out of business completely. Understandably, it has left the majority of companies operating under the popular "wait-and-see" approach.

Still, companies will need to start paying more attention to what's taking place in their supply chain and be prepared for any voids that may develop in the coming months, says Koenemann. "They need to start looking ahead because the process of contracting with a new supplier and completing the qualification process can take several months," he explains. "That creates yet another challenge: If they need to, will companies have the capability to change suppliers in a timely manner?"

To avoid potential problems down the road, more manufacturers are taking it upon themselves to monitor the financial health of key suppliers. Due to the economic conditions, more have opened up to the idea and are offering buyers greater visibility into their operation. In many cases, the circumstances don't leave either party with much of a choice.

"Companies are demanding that if an organization is going to be one of its critical suppliers, they need more visibility into their operation," explains Manish Govil, director of strategic partnerships for i2 Technologies, a provider of supply chain management software. "Especially now, trust will only take you so far."

There is, however, an upside to the high level of uncertainty throughout the supply chain -- it's preventing sourcing organizations from taking any steps that get them in trouble down the road. As a result, Govil says most companies are relying on tactical decision-making to help conserve cash immediately and bring production and inventory in line with the falling demand. Most long-term decisions are being delayed because companies simply don't have enough information to make them.

In the short term, initial instincts have led many buyers to either slow or effectively shut down the pipeline of material flow. This is particularly the case for parts and materials with long lead times, as it poses the threat of introducing several months worth of what could easily become surplus inventory. However, while Koenemann says these sorts of tactical responses can help companies put out a few fires, it likely won't accomplish much in the long term.

"Right now a lot of the effort is just brute force -- tactical activities to slow down the pipeline of material," he explains. "But eventually companies will need to step back and evaluate their sourcing strategies, so they can start thinking about how they can use lean/Six Sigma techniques to actually streamline the flow of information and material."

The Total Cost Revelation

It would be a huge understatement to say that a lot has changed for sourcing organizations in the past six months. Looking back to as recently as September 2008, oil had recently spiked at $144 a barrel while other commodities -- most notably steel, copper, aluminum and rubber -- went along for the ride. Manufacturers tried their best to adjust, but few could probably say they ever did.

The roller coaster ride also put other sourcing strategies in a new perspective. Manufacturers that relied on suppliers in emerging markets, low-cost countries such as China, India, Vietnam, started to realize how much these arrangements really cost. As oil prices escalated, transportation costs followed and these once lucrative opportunities didn't seem quite as prosperous. Coupled with a deteriorating global economy, many have started to give their low-cost country strategies a closer look.

"The trend of sourcing from low-cost countries was based on the assumption that labor costs were much lower," says Govil. "But there's a tradeoff. As transportation costs went up, costs related to carrying inventory rose and their ability to react was diminished. That's why more companies are starting to look at the total, true cost of sourcing -- not just what they are paying a supplier, but all of the associated costs as well."

In fact, experts say the benefits of offshore sourcing have been eroded so much by the fuel costs, large number of companies are bringing products back to the United States and working with domestic suppliers or producing the products themselves. This has made sourcing strategies evolve from the low-cost model of the last few years to a true understanding of the total cost of ownership for all of the parts and materials a company purchases.

"More companies want a sourcing strategy that is going to drive the optimal benefit for their organization," says Koenemann. "That doesn't just mean low-cost sourcing. You need to consider the entire package. You need to consider cost, delivery capabilities, quality, lead times and things of that nature, to ensure that the total cost of ownership is being considered when you start to source a product."

Many manufacturers optimize their sourcing strategies by sharing their improvement processes, and in some cases actually help to implement, lean manufacturing initiatives for their suppliers. These companies may evaluate suppliers on their lean capabilities to support their sourcing strategies. They're also beginning to build their lean manufacturing expectations into contracts with suppliers.

"In certain cases, manufacturers are in essence dictating it as a condition of doing business with them," explains Koenemann. "In other situations, they are making the introduction, trying to do the preliminary work to get the supplier's organization excited about it. But the idea is that they will actually take it and run with it themselves."

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