Supply chains and the impact of inflation

High inflation is causing supply chain disruption. Organisations need to act now to be resilient to the new reality.

Inflation measures the rate of rising prices in the economy. Inflation in the supply chain can cause a ripple effect on prices, causing supply chain costs to rise, which causes more inflation and increased prices. The current inflationary pressure is caused by increases in production costs, such as wages, raw materials, energy, and transportation.

If uncontrolled, inflation can result in a severe loss of consumer or organisational purchasing power. Typically, procurement mangers respond to high inflation by placing orders promptly, trying to secure supply and build inventory. Aggregated across the whole economy, this increase in demand can worsen inflation.

In November 2021, the Consumer Price Index (CPI), which covers gas, food, and rent among other costs, soared by 6.8% from the year prior, the highest increase in over 30 years, and continued to rise in 2022 before reaching 10.1% in July. This was due in part to ongoing supply chain issues.

Prices increase when supply reduces and demand increases. Since 2021, supply chain disruptions at ports and warehouses caused by bottlenecks and labour shortages contributed to shipping delays. These blockages left companies with reduced inventory. Simultaneously, consumer spending exploded past pre-pandemic trends.

Effects of Inflation on the Supply Chain
Procurement becomes more complex during inflationary periods. If increased costs are to be passed on to the buyer, then demand typically falls, therefore fewer goods or services may be required by producers. Sales and Operating (SOP) processes need a more focused, detailed, and agile planning approach with support from all stakeholders in the supply chain, including Sales and Marketing, and Warehousing and Logistics teams.

In a state of reduced supply, some companies had to raise their prices, creating the inflationary situation we are in. Although container shipping rates and delivery times have recovered recently, this hasn’t eased consumer prices. The Bank of England expects inflation to return to its 2% target in around two years. If this happens the rate of price increases will slow, but higher costs could remain.

The producer price index (PPI), which measures input costs for the production of goods, rose 24.0% in the year up to June 22. The price producers charged for those goods rose 16.5% in the year up to June 22. These are the highest rates recorded since records began. The cost of services has also increased from 4.2% in March 22 to 5.4% in quarter 2.

Inflationary pressure directly affects the supply chain. Persistent problems with port congestion and import containers are exacerbated by inflation and labour availability. Fuel prices are a huge factor in logistics as well, driving up transportation and freight costs that were already on the rise because of driver shortages.

Many supply chain and logistics professionals believe inflation has negatively affected their business. These impacts include capacity constraints as well as rate and price increases, supply chain instability, longer lead times and delayed orders, and continued issues with shipping containers. According to Materials Modern Handling, inflation has increased the chances of a large bankruptcy in US trucking this year. If a large trucking operator stops trading, moving freight and transportation will only get harder, reduce supply further and potentially bring about another spike in inflation. In the UK driver shortages have also fuelled inflation.

What can Supply Chain Teams do to mitigate the impacts of inflation?
In times of increased uncertainty, it is important to take a whole organisation approach to managing supply chain risks. Organisations should:

  • Stress test supply chains by mapping critical value chains and then running disruption scenarios (including variants and combinations) against them. Organisations need to understand their main cost drivers and where there could be considerable losses from increased costs and inability to supply. This raises awareness of supply chain risks, identifies possible gaps and allows appropriate strategies to be put in place to increase resilience.
  • Review your supply chain resilience, including the financial health of your critical suppliers. High inflation rates could result in financial distress for some or a change in behaviours. You don’t want to get caught out with an administration letter from a key supplier without a backup or contingency plan, or because a critical partner has changed strategy.
  • Conduct a thorough risk assessment of your critical suppliers and their sub-suppliers to identify which risks could have an impact on your supply chain and business resilience. Increased costs due to inflation tend to have a cumulative effect on the supply chain and if you have a business exposed to these increases then you want to quickly understand the impact and have response plans ready.

The Bank of England and others expect inflationary pressures to cool down, however higher costs across the supply chain could remain. This new reality means now is a good time to review how resilient your supply chains are, and where the disruptions risks may come from next.

Economic crises always have an endpoint or a period of evolution. If you can strategically set up your supply chains to deal with any eventualities, then through proper planning and monitoring, organisations can adapt appropriately to upcoming changes.

The world has already displayed a tremendous amount of resilience, it has survived a global financial crisis in 2008 and Covid-19 in 2020. Many economies display a level of dynamism in how they have approached recent crises and protected their most vulnerable.

Economic policy can work to help drive positive change and was remarkably successful during the pandemic. Supply Chain managers should look for opportunities to capitalise on this to help bolster their networks and minimise as many disruptions as possible.

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This article was adapted from an article by Zurich which can be found here.