Managing Costs of Supply Chain Disruptions

Albert Anderson
Al Anderson

Supply chain issues have been dominating the news for several months. Offshore products and supplies have been backlogged and so have their entry into many of the major US ports.  In addition to these backlogs, there are delays in shipping goods from US ports to customers. The backlog and delays are creating working capital strains on companies, especially those companies who have prepaid for products before they enter the US. During the pandemic, end customers have been extending credit terms which is creating additional working capital pressure. Many companies have exhausted their traditional credit facilities while dealing with supply chain issues. An understanding of costs and cost drivers are key issues for companies, and the unwieldiness of the supply chain have been extremely challenging.

Many manufacturers use just-in-time inventory management, lean manufacturing, and value stream, and the supply chain disruptions have resulted in increased freight costs. During the pandemic, containers, trucks, and ships were stranded in the wrong place (and always at the wrong times), which also increased administrative costs and delays.  Were these increased costs temporary and should be treated as a variance, or should they be built into the standard product costs? Permanent increases in logistic costs should be added to standard product costs; however, identifying what these increased logistic costs will be in the future is difficult due to the continued global disruption and disarray in the logistics networks. Consequently, the availability of containers, trucks, ships, and their increased costs need to be stabilized and returned to some level of normality before companies can reasonably estimate the amount by which product costs should be increased.

3 Practices to increase supply chain resilience and manage cost

1) To safeguard supply chain resilience and manage costs, companies must adapt a risk management mindset by identifying supply chain exposures and must pivot quickly to eliminate or mitigate these risks.  2) Companies should use demand profiling (DP). DP is simply the application of a “Time Series Plot” to the customers’ demand of a process. This is a tool, since understanding customer demand is extremely important and the correct interpretation of the plot is the key to its success. Initially, the data collected is historical, but after the organization understands the application of the tool, forecast data can also be used. For example, once the organization understands how demand is fluctuating, the process can be laid out and resourced accordingly: more staff could be deployed; inventory could be built ahead of time to serve the demand, and customers could be encouraged not to batch their orders, but to spread them to earlier hours. 3) Create collaborative contracting arrangements between companies and the sharing of cost and demand data is a fundamental lesson that arose from the pandemic. For example, the use of open-book accounting between suppliers that enable continuous improvement provisions in the contract that focus on sharing information (e.g., direct and indirect costs across supply chains) to provide gain sharing across supply chain partners. Continuous improvement changes include payment structures that reward rather than penalize failure and aim at providing appropriate behavioral changes through the supply chain.  The contract offers a reward when a product is delivered rather than a penalty for non-delivery of the product.

Supply chain resilience best practices

A continuous cycle of risk mobilizing, sensing, analysis, configuration, and operation will help businesses navigate supply chain disruption, now and into the future. The following are best practices to ensure supply chain resilience:

  • Contingency planning and demand forecasting
  • Organizations should perform cost/benefit analysis of potential risk mitigation strategies. This analysis should include all aspects of the supply chain to fully incorporate a financial understanding of different contingencies.
  • Access to real-time data
  • Mapping supply chain networks is the first step towards obtaining real-time data. Companies need quick access to information about suppliers, sites, carriers, parts, and products at risk, as well as mitigation processes.  
  • Establish multiple sourcing options
  • The pandemic has exposed the need for diversifying the supply base to reduce dependence on one factory, supplier, or one region. Cost/benefit analyses and working with associates from other specialties can evaluate the supply sources that are not vulnerable to the same risks.
  • Utilize inventory management and production capacity planning to enable material flow
  • Provide information that evaluates meeting customer demand while at the same time managing trade-offs between cost, quality, and time.
  • Transform the supply chain in responding to a dynamic business environment
  • Prepare financial cases for investing in new equipment or moving production lines, allowing companies to reflect on decisions related to make-or-buy, and the need to make process and technological improvements.
  • Use supply chains to create value for customers
  • By working with supply chain partners to deliver customer value, supply chain partners will do more than just perform basic functions and will ensure all parties have a stake in best outcomes and work together to achieve them.

Across businesses and industries, key learning for the future relates to increasing supply chain resilience and recognizing that despite all the pandemic issues, globalization is her to stay.  As a result, components of lean manufacturing should be enhanced rather than abandoned.  Related costing systems such as lean accounting, value-chain accounting, and make-or-buy decisions around different warehouse and logistics configurations will remain important. These important decisions will have implications for accountants and management accounting systems going forward.

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