We are bombarded these days with dramatic economic news: The Wall Street bailout, frozen credit markets, a weak U.S. dollar, and high oil prices. So far, 2008 has been the most unsettled economic period in many years.

What are supply chain managers to do now that they’re faced with these troubling trends? They must think more like global economists. Supply chain executives are uniquely positioned to take the lead in uncertain economic times. They can champion change, never more so than when the chips are down and corporate anxiety is running high. Here is a guide to what the supply chain manager can do and how to make change happen. First, let’s briefly review the tectonic economic shifts that are driving unprecedented changes in domestic and global business.

From a supply chain perspective, we can focus on three major and interrelated trends: the slowing U.S. economy and trade; the weak U.S. dollar; and high fuel prices. Let’s discuss these developments quickly in turn.

Slowing U.S. economy and trade: The U.S. economy is slowing dramatically, ushered in by a startling credit crunch and financial market meltdown. Real GDP growth has declined steadily from 2004, when the economy powered ahead by 3.6 percent in real terms, to an anemic 1 percent during the first quarter of 2008—and all bets are off for the third and fourth quarters. The current consensus is that the U.S. has entered a recession that may last for an extended period, and many of our trading partners are not faring much better.

Overall economic weakness has an impact on the supply chain on many fronts. The subprime mortgage mess escalated rapidly into an international crisis of credit, stock market values, and financial trust in September and early October. All of this will exacerbate U.S. consumption and trade in the months ahead.

The U.S. economic slowdown has already resulted in reduced imports. U.S. imports from China, for example, have fallen off sharply from the fast-growing trend of earlier years. The nominal dollar value of U.S. imports from China grew by an average of over 20 percent per year from 2004 to 2007; it was only 2 percent (on a year-to-year basis) during the first four months of 2008.

This is directly reflected in physical trade volumes as well. Import container volumes were down at many U.S. ports during the first four months of 2008. These declines, generally ranging from 5 percent to 10 percent, represent striking changes from steady growth over the past decades. In fact, they invalidate forecasts made as recently as early 2008 that import volumes would always continue to rise. The flip side for U.S. trade has been a boom in exports, up sharply in the early months of 2008.

Weak U.S. Dollar: Anyone who has traveled recently to Europe is painfully aware that the U.S. dollar doesn’t buy what it used to. In fact, since mid-2001 the dollar has dropped by 38 percent against the Euro, 30 percent against the Canadian dollar and 17 percent against the Chinese Yuan (see Figure 1). Weakened purchasing power due to the declining dollar has contributed significantly to the decline in U.S. import volume. Improved competitiveness on the export side, likewise, has been partly driven by the new low-cost position of U.S. manufactured goods and raw materials on world markets.

High fuel prices: Energy prices have soared: Crude oil reached $140 per barrel in July, five times its mid-2001 price. Today’s diesel price at the pump, ($3.88 per gallon, U.S. average retail, in mid-October 2008) is up by 28 percent over the past year (see Figure 2). Fuel price has a direct impact on freight cost, of course, thus hitting the entire supply chain. Fuel surcharges are well established in most modes. For truckload (TL) and less-than-truckload (LTL) freight, as well as for rail intermodal, this is usually presented as a percentage increase (or cents per mile) tied to the weekly EIA retail diesel price.

Crude oil reached $140 per barrel in July, five times its mid-2001 price.

Trucking, which accounts for the vast majority of transportation activity in the United States, has been severely distressed. According to a report by Avondale Partners, the trucking industry witnessed 935 bankruptcies during the first quarter of 2008. Shippers are affected as well. Building products and other relatively low value-to-weight ratio commodities that move long distances are hurting. A food manufacturer, for example, relying heavily on domestic truckload and LTL freight for nationwide distribution, faced a 26 percent increase in its freight budget at July 2008 diesel prices vs. their 2007 average.

How can a supply chain manager use these broad economic trends to their advantage? By applying global economic logic to supply chain design and operation. Change creates not only pain but also opportunity—and today’s tectonic shifts in the global economic landscape offer many intriguing openings. Enterprising supply chain managers can use practical economics to benefit their companies in four ways:

• Pricing: Reflecting updated cost-to-serve economics in product prices for specific customer segments and locations.
• Sourcing: Buying closer to point of use, partially reversing past globalization norms to reduce freight intensity.
• Making: Exploring efficient ways to manufacture and export more from the U.S., leveraging the currently weak dollar.
• Moving: Downshifting transportation modes and adding distribution locations to save fuel and reduce cost.

These strategies form the core of a supply chain playbook that will set your company apart from the competition. Rather than merely responding to tough times, the supply chain leader can build strategic advantage through differentiated services and performance. This is a goal truly worth pursuing.

With that in mind, here are 12 intelligent supply chain moves grouped under these four themes.

1. Set the right offer. Costs are rising, margins are squeezed, and sales are tougher to close. This is a good time to review customer services, including delivery, installation, and warranty. Is our service offer too rich for certain customer segments? Can we charge for delivery? Can we adjust bracket pricing to drive ordering toward slower, cheaper delivery modes? Can we change sales incentives to dampen end-of-quarter spikes? These analyses take on special urgency and provide opportunity for margin gains in the current difficult economic environment.

2. Update pricing with cost-to-serve. Freight and commodity prices have been soaring. It may be time for a significant price rise. A food manufacturer we assisted recently reviewed its zone pricing system. Major fuel price increases had made the zone differentials inadequate and led to a significant increase in product prices particularly for more distant zones. Reviewing customer cost-to-serve frequently is critical in these times. Supply chain managers should lead the charge to review pricing. Don’t leave it to sales and marketing.

3. Balance supply and demand by world regions. Regionalization is a critical means to address fluctuating exchange rates and higher fuel costs. The idea is to minimize risk of unforeseen currency shifts by matching supply and consuming market currencies. Also, fuel costs are generally linked to distance, so a more regional sourcing strategy can yield benefits for certain products and demand profiles. Products that are in the mid-range of their lifecycle, but that still experience high demand variability, are well-suited to regional sourcing, as shown in Figure 3. The ability to shorten the supply chain and respond rapidly to fluctuating demand can offset lower but more distant labor costs.

Products that are in the mid-range of their lifecycle, but that still experience 
high demand variability, are well-suited to regional sourcing.

4. Find sources closer to home. Higher fuel prices, a greener supply chain, and the weak dollar are encouraging more localized sourcing. Recently, a 170-acre farm in Bowdoinham, Maine, began shipping organic vegetables to the Boston market. At a distance to market of only 144 miles vs. 3,000 from California, Locally Known can sell five ounces of its mesclun at Whole Foods in Boston for a dollar less than the equivalent California-sourced product.

Others are beginning to tout the virtues of U.S.-made products as well. Room & Board, an upscale furniture store, devoted a two-page spread in its latest catalog to the theme, “Close to home—furniture made in your own backyard.” Craftmaster Furniture, sold two years ago to Chinese owners, stopped offshoring more production to China as Chinese wages and currency rose, making continued U.S. production more attractive.

5. Seek situations where “far-shoring” still works. International sourcing still makes sense in certain situations. But the sources are shifting, reflecting wage increases and exchange rate shifts that impact attractiveness. U.S. footwear imports, for instance, are now growing at a faster rate from Vietnam than from China, while Brazilian shoe imports are declining. Many mid-sized companies have yet to exploit lower-cost sources for products with steady demand and relatively high labor content. In a project for an airline, we found that onboard food service items could be sourced from China with delivered savings of over 25 percent. In several cases, the goods were already being sourced from China but via American distributors who were not passing on the full benefits of the low-cost source.

6. Mitigate commodity and exchange rate risk. Fuel is the most obvious commodity for which to consider hedging, but the approach can be valid for other commodities and currencies. Southwest Airlines is a great example of a company that got it right. The company hedged its jet fuel buy to a far greater extent than its competitors. As of late 2007, the airline had hedged 70 percent of its fuel needs through 2008 at an attractive price cap of $51 per barrel.

7. Maximize plant utilization. For manufacturers, weaker demand and higher input costs mean re-examining production economics. If plant utilization has declined, choices include taking on work for others to better use installed capacity, downsizing to smaller (and more modern) facilities, or selling plant and equipment in order to outsource. These make-or-buy decisions become more critical in a difficult economy. The Boston Herald newspaper, for example, announced in June 2008 that it would close its printing plant in Boston and outsource production to a Dow Jones Co. plant in Chicopee, Mass.

8. Move closer to market. Adding a plant or a co-packer closer to major markets makes sense, given higher fuel costs—as long as scale economies are respected. Often, no amount of distribution tweaking can generate the freight savings that an additional plant, on the opposite coast, can produce. With the era of cheap transportation at an end, plants aimed at serving different parts of the United States can be economically justified far more easily than five years ago.

We can expect to see more, possibly smaller and more flexible manufacturing plants in America than before, particularly for lower value-to-weight products. A case in point is the wood furniture plant opened by IKEA’s manufacturing subsidiary in Danville, Va., in May. This is IKEA’s first U.S. plant and it reflects the favorable delivered cost of U.S. manufacturing to serve the company’s growing base of U.S. stores.

9. Export to growing markets. The United States has become a low-cost country relative to many other places. Automobiles are a prime example. The traditional “Big 3” are ramping up their exports: Chrysler is shifting production from Europe to the U.S., while General Motors plans to export from the U.S. to Europe, Latin America, and China. BMW is boosting its production of the X3 premium SUV in South Carolina, much of which is aimed at European markets. Even used European cars are being re-exported to Europe. The cheapened dollar makes the cars competitive in Germany, even after the reverse ocean voyage and environmental fine-tuning.

Sourcing comparison between China and Mexico.

Moving

10. Move freight more slowly and cheaply by downshifting modes.Slowing down the movement of freight is a rational economic response to higher fuel prices. Rail, for example, is roughly three times as fuel efficient as truck, while barge is about four times as efficient as truck. Typical downshifting involves moving more Asian imports via all-water service to the East Coast rather than via West Coast ports and intermodal service.

In fact, intermodal container volumes are down slightly in the U.S. in 2008 to date after decades of strong growth. Meanwhile, Savannah’s import volumes are up, reflecting its strong role as the first stop for many Asian all-water services transiting the Panama Canal. The all-water route will become even more attractive in 2014, when the maximum vessel size via the canal rises from 4,500 to 14,000 TEUs.

We are also witnessing an historic reversal of modal growth rates between rail and truck (see Figure 5). After decades of truck volume growth at the expense of rail, we are now seeing an absolute reduction of truck tonnage and a widening gap with rail volumes.

After decades of truck volume growth at the expense of rail, we are now 
seeing an absolute reduction of truck tonnage and a widening gap with rail volumes.

11. Get closer to customers with more DCs. The optimal network equilibrium between cost and service shifts with higher fuel cost. Many U.S. distribution networks were designed and implemented five to 10 years ago when fuel was one-fifth its current price. The new tradeoff favors more DCs in order to partially offset the new, higher fuel charges embedded in transport costs.

Overall, if the “old” optimum called for five warehouses across the country, the “new” optimum expands to seven or eight DCs. As a result, we are likely to see an end to the historical downward trend in the inventory-to-sales ratio in the U.S. (which has declined by 14 percent from 2001 to 2008), as manufacturers add DCs to get closer to their customers.

Supply chain managers should dust off their network models, re-optimize the number and location of DCs, and put warehousing and transportation out to bid.

12. Create a more flexible distribution network. We can be confident that more change lies ahead. Thus, flexibility must be designed into the system. Supply chain managers can take the lead by promoting solutions that are inherently adaptable and scalable. Flow control in both Asia and at West Coast port gateways can add dynamic routing options to import volumes.

Importers can transload and redirect freight once it hits Los Angeles/Long Beach to a DC that is running short of inventory. Loads can be expedited by team-driver trucks in place of intermodal in case of need. And routing tools can be used to track international flows and flag movements that need attention or re-routing. The capability to rapidly slot new product sources into a global supply network will be a key differentiator for many companies in coming years.

For supply chain professionals to play their role at full potential, global economic thinking is essential. The right direction and resources can turn these thoughts into successful reality.