Labor Constraints, Supply Chain Disruption, and Rising Inflation

Michael Sluka

Along with the human life and health consequences of the COVID pandemic, the above three undesirable conditions have become COVID-associated legacies for business operators. There is correlation and intertwined causation amongst these.

Labor availability effects were the first to appear, initially and unsurprisingly, due to the virus itself reducing hours available from the stricken victims and the impacts of mandated shutdowns. However, not as readily anticipated is now a significant shift in working people’s mindsets regarding where they physically want to work. What started out as a work-from-home necessity has morphed into a work-from-home desirability, evidently across the globe. Here in the U.S. there was also an exodus from urban density and colder climates. Employer-initiated reductions in staff for ostensible cost savings during the first peak of COVID has resulted in being unable to recruit those workers back, delaying even further a revenue rebound after COVID has subsided from its first and most deadly version. Combining the earlier initial reductions and hiring freezes with the need to actively recruit replacement employment in just about all sectors, a more fickle and transitory mindset has developed about employment for many workers, especially in the young, mobile and functionally desired groups.

As CFOs, whether previously at companies or now at Nperspective, we did not focus on becoming recruiting or human resource experts. However, as CFOs, we do know that the ability to recruit is vital to all organizations. We also know that recruitment, and even more so, retention, can be improved greatly by assessing and evaluating organizational policies in an objective manner using data, not just intuition or hearsay. Job holders and job seekers alike are making assessments of company policies and atmosphere using data they can gather. It behooves ownership/management to do the same and set a course for competitive improvements where possible. In order to serve our clients better, Nperspective has formalized a partnership with a financial talent-focused recruiting firm. We have also established a partnership with a leading provider of organizational change software which delivers a business diagnostic to help enterprises assess their operational profiles and take actions using data-driven strategies.

COVID’s supply chain “disruption” might be more fundamentally described as supply chain “inadequacy”. The introduction to the problem came in the form of shortages in sanitizing products, toilet paper and personal protective equipment (“PPE”). Normal retail supplies were exhausted within hours of stocking and even the huge manufacturers of each could not meet demand. Consumers resorted to hoarding and seeking alternate channels. What once was an $8 tub of bleach wipes on grocery shelves became a $50 item on eBay. Given the age-old economic rules, supply shortage begat price inflation. As for PPE, a bright spot occurred with the somewhat famous business “pivots” … designer clothiers making face masks and breweries producing hand sanitizers. The act of “pivoting” became the most talked about business strategy of 2020. However, pivots, aside from possible altruistic exceptions, are mostly revenue related. These pivots historically convert existing supply chain resources into different revenue outputs, not typically solving for supply chain shortages per se.

Referring back to the interrelationship of this article’s title components, today’s shortage in chips for electronics, building materials and certain food products is ultimately more a labor availability issue than a raw materials issue. There actually is no issue in availability of sand (silicon), trees and cows. It is mostly the lack of a sufficient labor force needed to convert and transport raw materials into finished goods, relative to unanticipated demand due to people changing habits during COVID … with the occasional true “disruption” exacerbating it, such as Asian politics regarding semiconductors and a cyber attack on a large dairy producer.

Unfortunately, supply chain inadequacies (risks) are not readily mitigated, much less remedied if the planning was not done ahead of time and plan implementation not immediate. As company CFOs, we are often charged with also being the risk managers, and not always viewed favorably for it during growth periods. We have historically counseled on the risk of heavy customer concentrations, but the smartest of us also saw the risk in supplier concentrations. De-concentrating is an undesirable activity at best when things are going well and often, regarded as simply unnecessary. However, COVID has evidenced its value. Businesses that already had multiple supply options fared better than those that did not. Businesses that had proactive vendor relationships (maintaining deposits, minimum orders and negotiating faster payment for pricing discounts) generally received some preference as supplies tightened.

Much like the benefit of organizational behavior/resource analytics discussed for labor recruiting and retention above, the adoption and integration of a risk management assessment helps foresee and mitigate the effects of potential risks to all of a company’s vital business cycles. In the case of COVID, and in the case of future unknown risks, the cost of an ounce of prevention in normal times is way less than the cost of a pound of revenue loss when disruption occurs. Given the differing spectrums of risk amongst different industries and different company sizes and maturities, there is no one perfect checklist to offer. However, an external set of eyes is usually more objective than those within the business, and CFOs are usually more well-versed than others in identifying and assessing risk. If your company does not have an experienced CFO relative to risk management, Nperspective can help close this void. While our review will not replace revenue lost previously, it may well provide the insight and best practices to avoid the same when the next set of business risks arrive.

While “inflation” exists as a near-constant topic within economic academia, it has once again spread into the day-to-day lexicon of business owners. While academia looks at inflation mostly through the lens of money supply, business owners see it as increasing their cost of goods. As a result of the labor and materials shortages discussed above, inflationary pressure on the cost of labor and materials is increasing. While not a bad thing per se, serious inflation was not previously experienced by most of today’s business owners, at least not functioning as the actual owners of a business. That was the case for me; I started my career in the business world during the Ford administration, when inflation was being measured at 11% per annum (later moving to near 15% during Carter’s). I was starting off on the staff of one of the legacy “Big 8” CPA firms, observing how business ownership was dealing with the ever-increasing cost of materials and an accompanying rising cost of labor. The observations made, whether it was at the giant industrial (Borg-Warner) or a leather tanning operation run by two brothers, was that cost increases were being met with an increase in selling prices. The strategy generally achieved survival, but much like treading water, did not actually move anyone, or any business, forward.

However, two other observations I made during this era proved to be more instructive. One was something you could do and the second was what could happen if you don’t.

First, there was indeed a more pro-active way of dealing with the increasing cost component, and it was Japanese companies that brought it to the forefront. Employing Edward Deming’s theories, Japanese automobile and electronic manufacturers adopted “upfront” (work-in-process) quality-control and line measurement statistics (today’s “KPIs”) to find cost-savings continuously, resulting in their ability to easily undercut the American car pricing that was inflating every year. Pricing allowed them to break the previous barriers to entry, but it was their surprisingly good “quality” evolution, moving them from market disdain to dominance in a relatively few years.

Second, all the years of cost inflation during the 1970s and 1980s, melded together with complacent management practices, resulted in cost-bloated companies of all sizes. A few savvy, risk/reward financial firms saw the potential play of acquiring cost-burdened businesses with borrowed money and then using a cost-slashing theory to service the debt. Then, after a few years of producing improved income statements, initiated exit strategies to produce gains on sale of the smaller equity investment (not always, but often enough to elevate this theory to widespread adoption and refinement up through today).

Admittedly, except for the petroleum-crisis shortages, 1970s/1980s inflation was mostly generated on the “too many dollars” side (government spending combined with easy monetary policy), whereas today’s concern has its roots in multi-sector supply chain and labor shortages rooted in the COVID pandemic effects …”too few goods” or, more precisely, too few production resources to create enough finished goods). As a CPA, and later a CFO, I am not here with expertise sufficient to solve the shortage of electronic chips, building materials, food supplies and adequate labor pools, but hopefully I can provide some insight into activities that can help weather the times with better cost management practices.

The first tool of cost management is a “budget”, be it in profit & loss format or cashflows format. It is what you “expect” your business should achieve in sales dollars, followed by cost of those sales and the administrative costs of running the overall operation. The more granular you can identify costs expected to be incurred/spent, the easier it will be to find the unanticipated results when these happen. The “happening” part is revealed when you add your “actual” results for each line and calculate variances. Most all businesspeople reading this already know what I just typed. However, knowing what it is and ensuring it gets done each month are often uncorrelated things to the busy business owner. If you don’t have a budget (to actual), or more likely, don’t make it the same priority as a sales call, you are risking having small problems that are emerging turning into big problems that have arrived.

While a budget to actual is the first tool to have, it is not the most perfect tool to have. There is an issue regarding the level of granularity. Too little and you will miss seeing things you should … too much and you, as the business owner, will be spending too much time looking at immaterial detail. There can also be variances caused just by the timing of when recurring invoices arrive or if a large sale is recorded on the last day of the month or the first day of the next. If you are a manufacturing company or a construction company, work in process value estimations at the end of the month alone can throw results off greatly. Most business owners are not financial people. Most owners know what activities really drive the company’s success, but a lot of those activities are not recorded as specific items in the general ledger. After all, budgets existed back in the 1970s. So, is there a next-level tool?

After foreign autos displaced Detroit and hostile buyouts displaced many owners/managers , the 1990s saw the emergence of a new business practice called business process (re)engineering. Instead of waiting for someone else to make you uncompetitive or someone else to take over your ownership, business managers strove to find the reducible costs, quality losses and process inefficiencies on their own. For the larger enterprise, a QC department or an Internal Audit department was formed for the task. For the non-Fortune 1000, consultants were brought in to undertake the initial flowcharting of production, fulfillment, revenue and purchasing cycles. Sometimes, the outsiders’ fresh eyes saw the opportunities, sometimes the subsequent walkthrough with the company personnel found the savings or the improvements. Either way, it was infrequent that just the low-hanging fruit from the review didn’t pay for the exercise. At Nperspective CFO, we have now refined this to a joint process where company personnel provide the resources with direction/facilitation by us. Single product line companies can typically be completed in 4-6 hour sessions.

In order to maintain the benefits of the review/reengineering on an ongoing basis, the process identifies and formulates key performance indicators (KPIs mentioned above) to ensure each process continues to achieve the performance time/money goal that is desired/necessary. In short, no doubt most business owners today will think of price increases as their strategy. However, even the once powerful U.S. auto industry could not save themselves through price increases. As stated, these will have some short-term survival benefits, but the best action to weather the profit-depressing effects of inflation is not one of just passing on costs, but to be one of those businesses that find ways to decrease costs. The first step is to know and understand your costs, and the way to do that is to capture and analyze your costs. The best tools for doing that are (1) a budget exercise followed by (2) a budget to actual exercise. Then, to truly understand what activities drive costs, a (3) process documentation/evaluation is needed. Once the drivers are identified and inefficiencies and bottlenecks are eliminated, (4) measurements in terms of time or dollars spent, whether as whole numbers or in relationship to other activities or to process totals (various KPI formats exist) can be taken daily, weekly, monthly and captured in a “dashboard” report that allow process owners to quickly spot when cost targets are not being achieved.

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