OIL PRICES will SHAKE the Supply Chain



From the 1990’s through today many firms attempted to lessen production costs while building a sinewy supply chain. This was accomplished through manufacturing downsizing, offshoring, outsourcing, redesigning of plants and consolidation of duplicate facilities. The basic rationale for these movements was the goal of cheap oil. With this ‘new’ availability of cheap oil transportation cost became a secondary thought. The primary emphasis was directed towards reducing manufacturing costs, resizing plants to increase space utilization, consolidate duplicate facilities to reduce labor manpower and inventory levels.

So why is this trend slowly in a reverse mode?  The answer is simple: higher oil prices.  As the prices of oil have increased we see now the attention being shifted to the cost saving of transportation.  Transportation has always been important and directly related to the location of inventories, production facilities and overhead costs.  With the increase in prices other options has emerged:

  1. Sourcing and production closer to demand:  As cheaper manufacturing costs are continually offset by the increase in transportation costs there is a trend occurring now called nearshoring.  The results of this will be less landed costs, transportation costs, inventory and handling costs, import duties and taxation.
  2. Regional distribution centers: As oil prices raise transportation costs become more expensive.  As a result it will become vital to shorten distances between facilities and the final destination.
  3. Supply chain flexibility becomes the focus of the firm: Dedicated manufacturing must cease as oil prices and volatility increase. It will become important to serve the customer from the closest production plant.

It is true that with this flexibility will come increased production costs due to frequent set ups but it will reduce the transportation costs.

The higher the price of oil the more important a flexible strategy appears and must consider the impact this increase will have on transportation, supply chain strategies and the debate between offshoring versus nearshoring.

Impact on Transportation

Recent transportation strategies such as just-in-time delivery, quick and frequent shipments and a dedicated fleet are all based upon cheap oil prices. Quick and frequent delivery was designed to lessen inventory stock levels to increase the number of deliveries. However, as the reverse trend in prices starting taking place companies began to look for alternatives to save transportation costs. The three approaches that come to mind are the following:

  1. From just-in-time delivery to transportation capacity:  Larger lot sizes are moved less frequently and improved packaging techniques improve truckload spacing.
  2. Change from quick delivery to slower transportation modes: Shipments have been moved from air to ground or rail to reduce fuel usage and other transportation costs.
  3. Shifting from dedicated resources to shared resources: Due to price increases we have seen a corresponding increase in the use of third party logistics carriers and consolidated warehouses.

Impact on Supply Chain Strategies

Besides the effect on transportation oil prices affect other areas of company such as business strategy and the supply chain. Let’s see how.

Inventory or rather the increase in inventory levels will be affected by oil prices. Safety stock will be increased due to the need for more regional warehouses and lot sizes. At the same time less frequent deliveries will increase inventory levels or at the minimum keep them the same.

This is where the discussion of “push’ vs. “pull” comes into play.  “Push” or “pull” depends on a number of drivers; least of all is the type of product.  However, the most important to this discussion is economies of scale. The more importance that economies of scale are in an organization and the more value place on cumulative demands the more vital it becomes to manage the supply chain on a “push” model.  Of course, “push” may not be suitable for all types of industries. Each company must consider extenuating circumstances such as:

  1. Inventory position: Trade-offs between inventory and transportation weigh even more heavily on company. Positioning can have a dramatic impact on logistic costs. Take a hub-and-spoke network, items are moved from the manufacturing plant to a primary warehouse then to a secondary warehouse even before it gets to the customer. For this system to work must place high volume; low cost products at the secondary warehouse due to economies of scale. 
  2. Better service: Need to expedite items across your distribution channels due to poor service levels. 
  3. Supply chain integration: As oil prices rise it is necessary to reduce the supply chain variability. This can be accomplished by reducing lead times, shared information across the supply chain facilities and vendor-managed inventory.

Offshoring versus Nearshoring

The goal of this section is to pinpoint the particular product characteristics that will stimulate companies to relocate manufacturing to “nearshore” locales. Must determine the cost of moving infrastructure, manufacturing and assembly. In this determination or calculation should include the product’s bulkiness, cost to transport, the ratio of selling price to transportation cost and delivery time cost to the customers.

Another driver to add into the ‘moving’ calculation is changes in labor costs within different countries.  Over the last few years labor costs in China have sharply risen, much quicker than the rise in the USA or Mexico.  Due to these changes it may force some companies to open more distribution centers, each dedicated to a local region.  Other types of manufacturers may need to “redo” their manufacturing strategy and open plants closer to United States.

In general the oil price volatility will affect four areas: business, consumers, the environment and technology. Rising oil prices are forcing businesses to rethink their strategies like indiscriminate manufacturing and static supply chains. Supply chains must be monitored and evaluated on an on-going basis.  With these price increases come the realization to help alleviate the carbon footprint through cube utilization, decreased fuel consumption.  Lastly, the search is on for new technologies to enable industry to reduce consumption and costs. Some of these new technologies are the following: global positioning systems which allows for real time monitoring of vehicle use, aerodynamic trailers, automated tire inflators and single wide tires.

These increases in oil prices have caused a change in company culture and or strategies – implementing operational improvements and investing in environmentally sound technologies.