My recent conversations with the supply chain practitioners are dominated by supply chain risk — specifically geopolitical risks in light of the ongoing Russian invasion of Ukraine. Even companies that serve markets and rely on supply chains that are not directly affected by the conflict are starting to feel the effects of the war. Some may have believed themselves to be immune at one point, but now their perspective is shifting. As an example, a major retailer whose market presence is in the Americas realized that several of their shipments that originate in China pass through Russia to make their way to the west and are now subject to shipment backlogs.
Let us dive deeper into how supply chains are getting disrupted. Then I will also make specific recommendations for organizations to tackle these disruptions.
Here are some ways supply chains are being impacted by the situation in Ukraine.
- Shift in the centers of gravity of the demand: As of the beginning of April 2022, about four million Ukrainians have left the country for neighboring countries such as Poland, Romania, Slovakia, Hungary and Moldova. This has resulted in massive spikes in demand for basic necessities in these countries. At the same time, many companies have lost access to most of the markets in Ukraine and Russia (owing to sanctions). This means companies that normally operate in or have access to these countries have lost access to markets of about 180 million people. This kind of disruption causes major dislocation in the sources of demand and shifts the centers of gravity for demand, forcing organizations to rethink their supply chain design.
- Increased input costs: Russia is the second largest crude oil supplier in the world. Europe relies on Russia for around 35% of its natural gas. While the gas prices spiked in early March and have since come down somewhat, ongoing uncertainty has kept prices above historical norms. Prior to the invasion, the Euro-area inflation was expected to be about 5.8%. Now, this risk is further amplified. Given Ukraine and Russia have been major exporters of grain and seed oil, there is a widespread concern about escalating costs of food and basic essentials. As inflation concerns mount, companies are genuinely concerned about the input costs increasing. For the longest time, supply chain organizations’ major objective was cost optimization.. Then COVID induced disruptions elevated the need for investing in supply chain resilience. However, inflation pressures can challenge companies’ agenda on resilience initiatives.
- Increased shipping lead time: More than 6,000 miles of railroad runs through Russia and connects Eastern China with Western Europe. Last year, goods valued at about $75 billion were moved between China and Europe on these rail lines, making up about 4% of the total trade between the two sides. Now, these shipments are being shifted to ocean and air, radically reducing rail shipments. Given that now the ocean carriers are avoiding several of the major Russian ports, the reroutings are further straining European ports. Even air transportation from the east is taking longer time as several carriers are avoiding Russian airspace and the conflict-torn region. This further adds to lead times. Overall, even companies that don’t have market presence in Russia or Ukraine, or even Europe for that matter, are being impacted as sourcing happens to be from the east.
There are just three of the many more disruptive forces with knock-on effects across the global supply chains.
Now, this brings up the question of how companies should be prepared. The following pointers are based on my conversations with several of our customers who are taking a combination of the approaches highlighted.
- Ensure the rules and assumptions that guide your supply chain decisions are up to date: One of the major assumptions supply chain planners make is about lead times between supply sourcing and receiving locations. Take the time to understand which of your routes are significantly impacted and adjust the lead time assumptions accordingly. Without this, your planning and execution can quickly fall out of sync and result in a lot of firefighting. Likewise, you may have made assumptions about supply being limitless for certain raw materials that have traditionally been available in abundance. You will need to reassess this assumption, consider supply constraints, and accordingly plan this constrained allocation to decide how you prioritize customer commitments.
- Adjust supply chain design more frequently than ever: As radical shifts in the centers of gravity of demand take place and the often-used transportation modes become inaccessible, organizations need to revisit their supply chain design and dynamically course correct. Switching to alternate sources of supply or modes of transportation should be considered as appropriate, and such alternates should be activated on a short notice. Order minimums and multiples along with replenishment frequencies should be adjusted, especially as you prepare to stockpile highly constrained materials. Making such assessments is typically beyond the scope of planning and execution processes, which tend to be downstream to supply chain design and focus on demand-supply balancing decisions. Organizations need to get far more dynamic about designing their supply chains and adjust the routes to market. In addition, these changes should be communicated to the planning and execution systems in the form of rules and assumptions. .
- Prepare and disseminate business continuity playbooks across functions: With radical shifts in demand, organizations need to be far more prepared with a range of possible scenarios. These scenarios should be able to take alternate views of demand signals and align them with the increasingly constrained supply and capacity sources. This means organizations should develop business continuity playbooks that prepare them for a variety of demand scenarios and also offer the ability to activate the most probable scenario as the decision time nears. The nature of the disruptions being faced at the moment require significant cross-functional collaboration and alignment. You will need to engage your procurement, sourcing, and finance teams as part of such an effort.
- Create a Baseline for your Cost-to-Serve. Then Optimize: As input costs rise, organizations need to take a rigorous approach with their Cost-to-Serve modeling, factoring in a variety of fixed and variable costs along with the input costs. This helps them understand what additional costs they might incur while meeting customer expectations, and then make the right decisions as they seek to find offset opportunities. Such opportunities will involve switching modes of transportation, or skipping nodes of the network altogether, while increasing the speed to market and reducing the Cost-to-Serve.
- Be dynamic in creating and executing sourcing events: As traditional routes and sources of supply fail, companies need to be far more nimble in creating sourcing events and lock in alternate sources of supply and modes of transportation. Such alternates should be based on the gaps in capabilities identified while redesigning the supply chain. In a highly constrained world, those that are the fastest get the early lock on the available supply (whether it is materials or shipping capacity).
All in all, the current situation should provide organizations an opportunity to introspect and further strengthen their supply chains. The aforementioned recommendations should help in this regard.
Dr. Madhav Durbha is the Vice President of Supply Chain Strategy Coupa Software, where his team helps customers and prospects solve various supply chain challenges. Prior to Coupa, Dr. Durbha held positions at LLamasoft, Kinaxis, JDA Software and i2 Technologies, Inc. With more than 20 years in the supply chain industry, Dr. Durbha has broad experience in strategy & process consulting, supply chain software, program management, software application development & deployment, machine learning and data science. He received his Ph.D. in chemical engineering from the University of Florida and his bachelor’s degree in chemical engineering from the Indian Institute of Technology at Madras.