Focusing on Cost Plus Risk Can Help Organizations Move Forward

By Sue Doerfler

The coronavirus pandemic has been characterized by emotional shifts in consumer-buying behavior, and as the economy opens up more, there will be a dichotomy between organizations that have dealt well with such consumer-related demand issues and those that have not.

“Many companies that had a spike in demand for consumer-related products when COVID-19 was in its full-steam-ahead mode were able to deal with it,” says Steve Bowen, founder and CEO of global supply chain and operations consulting firm Maine Pointe, headquartered in Boston. But they may be less successful as demand levels off, flattens out or comes back down, he says.

Consider lumber: Its price hit an all-time high of US$1,670 per board feet in early May before toppling 45 percent by the end of June. By July 7, lumber prices increased 11 percent. “Why is this happening? Well, it’s consumer behavior,” Bowen says. “Consumers had extra cash flow, whether that came from government’s economic impact payments or that they weren’t spending money on travel and entertainment, so they did home projects and drove up the price of lumber.”

A dual-shortages situation — of housing and workers to build homes — has started to level out, he says. And with businesses and travel reopening, home do-it-yourself projects have come down by 40 percent, he says.

The difference between companies that will be able to handle consumer-related demand fluctuations and those that don’t, Bowen says, centers on three factors:

Foresight. Many organizations’ forecasts and planning — whether for their supply chain or manufacturing capabilities — are based on historical experiences, Bowen says, “therefore, they’re almost guaranteed to be wrong. Emotional shifts drive consumer behavior, which is what drives demand. But most companies aren’t connected to any foresight of consumer behavior.”

Contingency plans for spikes or declines in demand. Although supply availability for some materials and components, like semiconductors, remains an issue, “companies that operate smart should have a proper review of their SKUs,” Bowen says. “They can focus on which SKUs they can make with the supply they have and continue to get, that will sell the best and will make them the most profit. They can then optimize their profits.”

However, many organizations feel they must strive to satisfy all their customers or consumers all the time, he says: “That creates challenges when it comes to profitability because in these times, they can’t satisfy all those demands no matter what they do.”

Even organizations that review SKUs and focus resources to satisfy as many customers as possible may encounter lingering issues: “They don’t structure a program that can stay in place. The SKU rationalization or focused effort becomes a response out of desperation — and a temporary fix,” Bowen says.

A balanced focus on cost and risk, not just cost. Many organizations struggle with doing this, Bowen says. They tend to emphasize consumer-centric factors at the expense of risk factors like geopolitical, environmental and corporate social responsibility implications, he says.

Despite wanting to be more strategic, organizations can have trouble pulling together the right data in the right format for balanced cost-and-risk decision-making and modeling to meet the demand changes they encounter, he says. Getting company leaders to agree about what should be included in modeling scenarios also can be difficult.

Also, companies often make assumptions that put extra risk into their business, Bowen says. He cites an example of two companies in the same business: Company A, which single sources 86 percent of its products and claims that moving from single sourcing to optionality and dual or triple sourcing would create numerous added costs. Company B, which was at 75 percent single sourced, has, over the past two years, lowered its single-source dependency to 54 percent while reducing costs.

“The pandemic showed that if you’re single sourcing and need one part for a product but can’t get it, you’re not going to be able to make that product,” Bowen says. Having a balanced focus on cost plus risk can increase an organization’s competitive advantage, he says.

Employing integrated business planning integrated with data analytics can help companies shift from functional silos and traditional ways of operating to more strategic modeling and decision-making. Also, Bowen says, rethinking sourcing and supplier relationships can make a difference. “There needs to be a different kind of partnering with your supply base,” he says. “In today’s world, it’s, ‘I want the product with the expected quality at the lowest possible price and I’m going to negotiate until I think I get to the lowest possible price.’

The supplier relationship should be open, he says, with this conversation theme: “I know you need to make a decent margin to do your business; I need to make a decent margin to do our business. So, let’s work together so you make money, I make money, and we all win.”

Bowen says, “The lowest-cost push is so ingrained in us.” However, he adds, by having foresight, developing contingency plans for spikes in supply and demand — and by making risk part of the planning equation — organizations can better manage demand issues, their customers’ needs and changing consumer behaviors, and come out ahead during crisis times.

About the Author

Sue Doerfler

About the Author

As Senior Writer for Inside Supply Management® magazine, I cover topics, trends and issues relating to supply chain management.