In the post-pandemic supply chain environment, both manufacturing and distribution sectors have faced an acute shortage of raw materials, components, resources, and transportation services. This created a ripple effect that led to severe inflation throughout the value chain, negatively impacting the end consumers with increased prices for finished goods & services and delayed global economic growth. Through this article, Vineetha Jayaram, Global Category Manager, nVent, focuses on potential solutions to reduce the impact of inflation for an enterprise by reviewing the primary sources and potential corrective actions including cost-avoidance measures.
To determine the measures to control inflation, it is crucial to first provide a baseline on how government institutions track and report inflation in different countries. The most common inflation metrics in the United States are the Consumer Price Index (CPI) and the Producer Price Index (PPI), reported by the US Department of Labor’s Bureau of Labor Statistics. CPI is the average change over time in the prices paid by the urban consumers for a market basket of goods and services, while the PPI is the measure of the average change over time in the selling prices by producers for their output.
According to the January 2023 CPI, and PPI reports, all items’ CPI index increased 6.4% for the 12 months ending January. The energy index rose 8.7% for the 12 months ending January, and the food index increased 10.1% over the last year. Similarly, the PPI index for final demand rose 6% for the 12 months ending January. Also in January, a 1.2% rise in prices for final demand goods led to an advance in the final demand index. Prices for final demand services also moved higher, increasing by 0.4%.
India uses similar indices to measure inflation: the Consumer Price Index (CPI) and the Wholesale Price Index (WPI), which also measure the change in prices of goods and services. According to a recent Forbes article, the CPI analyses the retail inflation of goods & services in the economy across 260 commodities. The WPI analyses the inflation of only wholesale price or bulk goods across 697 commodities. CPI data is provided by the Ministry of Statistics and Programme Implementation (MOSPI). The Office of Economic Adviser, Ministry of Commerce and Industry publishes the WPI data.
According to the February 2023 data, annual consumer price inflation in India accelerated to 6.52% in January 2023, the highest in three months, compared to 5.72% in December and above the Reserve Bank of India target of 2-6%. The annual rate of inflation based on the WPI index was 4.73% in January 2023 (over January 2022) against 4.95% recorded in December 2022.
In the article, ‘What is supply chain inflation and why is it driving up consumer prices now?, professors from the University of Oxford highlighted, “The interconnectedness of global supply chains means that when one price goes up, others tend to follow.” According to the experts, three factors contribute to inflation: the increase in the price of goods and services, labor costs and energy costs. “While consumer price inflation has been relatively low and stable for the last 20 years, the last few months have seen a big jump in price growth alongside lots of discussions about the role of supply chain disruptions,” said the authors.
The primary sources of inflation are all interrelated as these factors contribute to the final price of the finished products and services sold to end customers. The focus here is on potential solutions to reduce the impact of inflation for organisations in their supply chains by reviewing the primary sources and possible control measures, including cost avoidance actions that can be implemented to limit inflation.
SOURCES OF INFLATION
Raw Materials and Packaging:Material prices, especially for base metals, plastic resins, and corrugated boxes, had increased over the last three years due to multiple events when current demand exceeded supply in the market. These include raw material shortages due to unforecasted increases in customer orders, rising energy and fuel costs, production disruptions related to the Covid pandemic, geopolitical events, and worker protests when manufacturers, critical materials distributors, and suppliers were forced to shut down operations, citing force majeure temporarily or permanently. Common packaging materials, including paper and plastic prices, correlate with the cost of the base materials, which have all increased significantly from 2020 levels for the same reasons.
Labor: The talent shortage in critical sectors such as retail, healthcare, energy, agriculture, and transportation has impacted global supply chains leading to higher labor costs. According to Deloitte’s 2022 Retail Industry Outlook, based on interviews with 50 senior retail executives, labor remained the primary challenge for 2023. The World Health Organization predicts 15 million healthcare workers worldwide shortfall in 2030. The International Centre on Nurse Migration projects that there will be a shortage of 13 million nurses alone by 2030, up from a lack of 6 million before the pandemic. The Association of American Medical Colleges (AAMC) predicts a shortage of between 37,800 and 124,000 physicians by 2034.
With severe labor shortages and increased demand, organizations are forced to raise wages to retain their current workers and attract new workers, significantly increasing the costs for skilled labor occupations across sectors. Supply chain disruptions also mean manufacturers may need to pay their existing workers for overtime hours to meet delivery expectations to end customers, increasing the organization's overall labor costs. These worker wage increases also impact lower-cost countries in the Asia Pacific region, such as China and India, which are considered the primary manufacturing hubs for major global corporations.
According to CNBC and the annual Salary Trends Report by data company ECA International, the Asia Pacific Region with India, Vietnam, and China will see the most significant increases in real wages in 2023 as compared to countries in other regions. Real wages are the wage growth number considering the inflation rate. According to a survey conducted by Aon plc, India is the country with the highest salary increase in 2022 which is 10.6%, as compared to other countries, including Germany (3.5%), UK (4%), USA (4.5%), China (6%), Brazil (5.6%), and Japan (3%). These outcomes force these same corporations to raise the prices of the finished goods and services to maintain profitability, thus increasing inflation across the value chain.
Transportation: The Inflation related issues in the transportation sector are more complex and multifold as these impact modes across the ocean, air, and land, including railways and road transportation. Since the pandemic, the ports congestion and shutdowns in China, Europe, and the United States, the shortage in ocean cargo containers with increases in blank sailings, the low supply of trucks in the US, especially for full truckload shipments (FTL) and also the scarcity of truck drivers along with the rising fuel and diesel prices have all led to a sharp rise in freight costs for international shipping. However, these prices have fallen significantly since Q3 2022 due to a steep decline in consumer demand and reduced congestion at the ports, according to Freightos, the digital booking platform for international shipping. Freightos also reported that international air cargo - pre-pandemic rates typically ranged from approximately $2.50-$5.00 per kilogram, depending on the type of cargo and available space. Costs rose sharply during the pandemic, reaching $4.00-$8.00 per kilogram. As of early 2023, rates have dropped to around $3.00-$7.00 per kilogram, which is still higher than pre-pandemic rates.
Environmental Social and Governance (ESG) Impact Initiatives: Investments in best-inclass practices and tools to ensure transparency and accountability within the end-to-end supply chain concerning ESG initiatives are top priorities for all organizations. However, organizations may need to increase the cost of their goods and services to account for these investments. In the current business environment, companies are focused on investments based on multiple factors
- ESG disclosure requirements based on laws and regulations by country and sector, ESG reporting methods such as Global Reporting Initiative (GRI) and Sustainability Accounting Standards Board (SASB) and reliable data management to gain investor trust and manage customers, suppliers, employees, and other stakeholders’ expectations to achieve sustainability goals and maintain a substantial brand value.
According to a 2022 Deloitte Sustainability ESG Executive Survey of 300 executives in key US public companies, 35% reported data quality as the primary challenge. Another 25% said access to ESG data was the next biggest challenge. Further investments will be necessary to ensure the availability of reliable data for ESG reporting. In addition, 99% of the executives reported that they are likely or very likely to invest in more technology and tools to accommodate future requirements in the next 12 months. These additional investments will further increase the cost of production of the final goods and services.
Geo-political events: A wave of unanticipated disruption events has shaken the global economy in the last three years, starting with the Covid-19 pandemic, including China’s Zero-Covid Policy, tensions between US and China, and the Russia-Ukraine conflict as the primary occurrences. These have all led to significant supply chain disruptions with increased lead times which reduced the global supply of goods and services, leading to a sharp increase in customer prices.
Foreign Currency Exchange Rate Price Fluctuations: It is important not to underestimate the role of currency exchange rates in impacting inflation. For example, the imported materials, goods, and services, especially from countries such as China, India, and Russia, became more expensive due to tariffs, additional duties, and trade sanctions, which weakened the currencies in these countries leading to inflation or an increase in the prices of goods and services in consumer countries.
Digital Transformation: Organisations need to invest in supply chain demand visibility enabling technologies and process innovations to help reduce overhead costs, including labor needs for repetitive tasks, assembly, and packaging operations. These tools should also help identify and manage relevant and reliable data for analyzing leading market price indicators based on factors such as specialty material capacity trends and geo-political events, to minimize the impact of future inflation.
Supply Chain Diversification: Supply chain leaders must think out of the box to combat inflation by diversifying the organization’s current supply base. This could be through allocating the current purchasing spend across multiple sources for critical parts and priority projects to reduce the impact of price increases or entering new low-cost supply markets for these services. This strategy applies to direct, and indirect purchasing spend categories and helps optimize costs across the value chain by sourcing alternatives for raw material manufacturers and logistics providers, including inland and ocean freight, packaging companies, and even staffing agencies used for permanent and temp hiring needs. The other forms of diversification could be through domestic manufacturing to mitigate the cost impact due to geopolitical and international trade events and insourcing by expanding internal capacity and capabilities to have better control and visibility into the total cost of doing business.
Effective Contract Management: Contracts minimise unanticipated price increases with obligations defined for each party involved. These can be an efficient cost-avoidance tool and help mitigate inflation in numerous ways. First, a price lock agreement for materials based on market indices and an agreed market rate can help control raw material costs by reducing the impact of future price fluctuations. A standard supplier stocking agreement for products with steady demand can help define firm Minimum Order Quantities (MOQ) and provide price discounts based on volume to reduce overall inventory costs. Contracts can help control inflation while setting up new high-volume, highgrowth supply markets by keeping price fluctuations tied to volume, market indexes, and the increase in business over the long run.
Supply Chain Collaboration: Inflation mitigation requires cross-functional solid collaboration in the end-to-end supply chain process, which includes both internally within the organization at the executive levels and between suppliers, manufacturers, and distributors. These opportunities for collaboration could be in investments to mitigate inflation related to Environmental, Social, and Governance (ESG) goals, new manufacturing or warehouse locations, cost-efficient packaging configurations and alternatives, and automation or artificial intelligence technologies to reduce labor inefficiencies and maximize throughput. In addition, maintaining mutually beneficial partnerships and leveraging long-standing relationships that help control the inflationary shock across the value chain to maintain business profitability becomes necessary.
External Strategic Partnerships: Since inflation is a global issue, multinational organizations must take advantage of government measures to combat inflation, including monetary policies and community resources, while engaging with external trade associations, non-profit and academic institutions, and government bodies to promote dialogue and solutions to keep prices down.
In many countries, the governments offer various subsidies to increase domestic manufacturing and combat inflation, especially in Agriculture, Energy, and Housing sectors, while reducing import duties for certain critical raw materials. It is essential for organizations to continuously monitor and engage with key government institutions to participate in these benefit programs. Potential solutions for labor cost increases would be strategic alliances with professional trade associations for skillset evaluations and academies for employment opportunities within skilled labor occupations to graduating students. Organizations could also partner with community organizations for training programs to upskill and retain their current employees instead of investing in new hiring resources.
Value Engineering Initiatives: Value engineering helps to reduce costs during the design stage of the products by reviewing all the lifecycle costs and benefits. Examining every step in the process of the conversion to the final finished part can lead to some significant cost savings in manufacturing critical components and assemblies, such as potential cheaper alternatives for materials, fewer finished goods offered through the process of rationalization that can significantly reduce labor and overhead costs and the use of more cost-efficient technologies and techniques to meet project goals.
In a nutshell, inflation implies a greater challenge for global supply chains. To avert this eventuality, stakeholders must enhance their stock visibility, improve their logistics planning and cut production costs to remain competitive. Companies must make bold moves in enhancing their digital capabilities to help enable improved forecasting, enhanced end-to-end supply chain visibility and help unleash the power of people. I would like to conclude this article by stating a very apt statement mentioned in an Accenture report, “The cycle of rising inflation requires a response that combines new technologies and the re-skilling of people. This combination of human ingenuity and technology underpins a more resilient supply chain. It doesn’t just help companies manage inflation but can flex to support innovations that drive new sources of growth. To beat the inflation-disruption cycle, the time to act is now.”