How to insulate your business from supply chain shock

The pandemic has left no sector untouched, but some areas have been hit harder than others. For example, retailers have faced spiralling raw material prices, increasing shipping costs, problems sourcing containers and factory outages. And if that wasn’t enough to deal with, the UK’s truck driver shortage could yet deepen the disruption to UK businesses for some time to come.

The gravity of the supply chain issues has been underlined by one key metric – accelerating inflation. As the world tries to find a post-pandemic ‘new normal’, key business inputs, such as energy, are soaring, with raw materials and commodities getting harder to source consistently. UK consumer price inflation stood at an annual rate of 3.1% in September, following a reading of 3.2% in August and 2% in July. The Bank of England expects inflation to accelerate above 4% by the end of the year, more than double its target.

Investec understands the unflinching commitment of family and founder-led businesses to surmount the challenges they face. Their flexibility and inherent ability to take a truly long-term approach will be crucial in overcoming the supply-side squeeze.

Whatever sector family and founder-led businesses may operate in, we believe owners and management teams must get on the front foot to mitigate the adverse economic impact of the supply-chain crisis. We outline a four-step guide to reviewing supply chain resilience, from technological solutions to stress testing supply chains.

Having the right technology is crucial in building resilience in your supply change management systems. But to understand the robustness of your processes, leaders need to ask the right questions. For example, do you have secure integrated data sources that seamlessly provide real-time information regarding inventories, suppliers, and sales?

Visibility about how to ensure value is injected into the chain is critical. You should know your inventories and those of your ecosystem – the inventory levels of your suppliers are as important as yours.

Transparency over the weakest link in your value chain is critical, and technology is the best method to measure this efficiently.

Businesses must estimate inventory across the chain and understand how they ensure the smooth delivery of products and services to clients. Transparency over the weakest link in your value chain is critical, and technology is the best method to measure this efficiently.

While upgrades in technology come at a cost, we believe the capital invested in the right systems will be relatively small compared to the business impact of lost sales and reputational damage. Technologies such as big data and the internet of things are becoming integral to logistics in driving efficiencies across the supply chain. In the long-term, these disruptive technologies reduce operational costs and provide better ongoing monitoring and transparency over business strategy and, ultimately, better customer services.

The disruption to supply chains is down to the profound impact of the pandemic on the world’s economies. Even as demand has bounced back, the lack of consistency between different national recoveries has created imbalances across business supply lines, resulting in displaced containers to widespread shortages across the world from plastics to industrial metals.

For example, the shortage in silicon metal, sparked by a production cut in China, has seen prices skyrocket 300% in less than two months. Meanwhile, Apple suppliers have warned that disruption to energy supplies is threatening their supply chains.

All this means that measuring supply chain efficiency is getting more challenging. On top of a shortage of containers and factory outages, we also see heightened tensions between the US and China and the UK and Europe. The result is that businesses with more complex supply chains can’t take anything for granted.

Alongside technology and data analysis of supply lines, businesses must also factor in the broader macro and political picture. To mitigate risk, companies may consider diversifying suppliers – even if this results in higher marginal costs – to ensure more resilience across their supply chain. It is important to consider the entire flow of materials so you can avoid a detrimental impact on product quality, pricing, and availability.

Running a successful business is often about taking external risks off the table – particularly if there is a more complicated economic and political picture. For businesses, this means re-sizing risk around currencies, commodities and interest rates threatened by more erratic and unpredictable price swings.

For example, if you’re an importer or exporter with currency or commodity exposures or are looking to diversify your supplier base, you may want to consider hedging those risks.

When evaluating risk mitigation strategies, it is crucial to consider the supplier-facing perspective of the supply chain and take into consideration downstream risk, particularly cost and price uncertainty, and long-term stakeholder relationships within your ecosystem.

Rather than a cost, businesses can think about robust risk management and hedging techniques as a way to insulate themselves against extreme events.

Risk modelling and analytics can allow you to view your overall exposure with clarity, proactively spotting risks and opportunities. This enables business owners to eliminate blind spots and make better decisions. Rather than a cost, businesses can think about robust risk management and hedging techniques as a way to insulate themselves against extreme events.

Investec is working closely with its clients to review their existing hedging programs, in light of unexpected dislocations, due to the ongoing supply chain issues. Updated cashflow forecasts are compared with existing hedges and where this shows mismatches, we will work with clients to revise their hedging profiles to reflect the new reality.

We have also seen clients make greater use of flexible hedging contracts that give them freedom over when they take delivery of currency, rather than have this occur on a fixed date, as is standard. This reflects the greater uncertainty over timings and reduces the administrative burden of matching hedges to fluctuating delivery timetables.

Clients are also putting more emphasis on having discretion over the amount of currency that they have hedged. They can achieve this through hedging products that have in-built flexibility in the way that they work. Another important aspect of allowing our clients to adapt to changing requirements is achieved by running multiple scenarios, where we model foreign exchange or cashflow volatility, to ensure that portfolios are sufficiently robust in the face of unexpected events.

The Covid-19 pandemic has elevated the issue of supply chain resilience to the boardroom. McKinsey estimates that even brief 30-day disruptions caused by supply-chain vulnerabilities can result in 3 to 5 percent margin gaps in earnings before interest, taxes, depreciation and amortization (EBITDA).

Unfortunately, there is no clear end in sight. Even recently, the US Federal Reserve accepted supply chain issues are likely to be with us for a while. The Covid-19 Delta variant of the coronavirus is still at large in various places worldwide, impacting factories and ports in Asia that send container ships of computer chips and consumer goods to the UK, US and beyond.

We believe businesses should run stress tests to understand where supply chain issues will cause a financial impact and have a contingency plan if this crisis is more than transitory.

This means identifying critical supply chains that need consistency of supply or could face surges in demand from black swan events or crises. Firms can develop specific risk scenarios and stress test supply chains for essential materials flow and integrate the results of stress tests in overall risk management strategies. Only then will they start to gain a clear picture and build long-term resilience.

UK businesses have undergone unprecedented levels of economic shock and have had to navigate a uniquely challenging environment from successive pandemic-induced lockdowns to a global supply chain crisis. Fortunately, there are clear, pragmatic steps for family-run and founder-led businesses that can help mitigate any adverse impacts.

By stress testing supply chains, reviewing key relationships and developing the right technology, companies can not only survive but also build enhanced levels of resilience into their business models and inject new value into their supply chains.