Far from what some consider the dismal science, economics drives most decisions in the supply chain. Supply chain managers need to be fully aware of the economic conditions that drive their business, their suppliers and their customers.
In this age of Big Data, one cannot ignore all of the information and analysis available today to assist in making suitable supply chain decisions. It is up to supply chain professionals to identify, analyze and track the key economic trends and indicators that not only impact their business but also offer a window into their supplier’s strategies.
Micro and macro drive suppliers' cost decisions
There are two major areas of economics, and both are critical to those in the supply chain.
Macroeconomics is big picture economics. It is the study of the economy in the aggregate, including fiscal policy, gross domestic product, interest rates, unemployment and inflation. Macroeconomics decisions drive the overall economy.
The monthly U.S. jobs report and the prime interest rate are examples of macroeconomics.
Microeconomics is focused on the decisions of companies, consumers and markets and includes supply and demand, production decisions, cost/price analysis, labor rates and the daily tradeoffs companies make every day to run their business.
Aligning supply and demand in your company’s sales and operations plan is an example of microeconomics.
Supply chain managers have a responsibility to be internal business resources. Their direct access to a wide range of practical market intelligence ... creates the perfect opportunity to be internal company advisers.
Supply Chain Dive
Supply chain managers deal with macro and micro decisions all of the time, especially when analyzing suppliers’ cost drivers.
Consider a supplier in the United States needing to raise prices to compensate for increased labor costs driven by employee shortage induced wage pressures. Understanding the employment trends and associated wage analysis is a macroeconomic element. Pricing between the buyer and seller during contract negotiations is a microeconomic issue.
Buyers and sellers meet on the supply and demand curve
Definitions of economics vary. Some academics look at the concept of scarcity, and what people are willing to pay for a particular product or service. Other economists look at it as the study of production and consumption.
In any event, the heart of economics familiar to supply chain managers occurs in the marketplace where buyers and sellers meet and bargain over goods and services. That transaction rests comfortably within the supply and demand curve.
Demand is the quantity consumers are willing and able to buy at different prices. Supply is the quantity of goods and services businesses are willing to provide at different prices. The illusive equilibrium point is where supply and demand are equal and where the price will settle. The equilibrium point is in constant motion, reacting to incremental or large fluctuations in supply and demand.
The heart of economics familiar to supply chain managers occurs in the marketplace where buyers and sellers meet and bargain over goods and services.
Supply Chain Dive
Let’s take a look at a supply and demand example relevant to most anyone in the supply chain, or even as a consumer.
The price of a barrel of oil is quite volatile and has been on the rise for the past year or so. This increase impacts all businesses, from transportation companies dealing with higher fuel costs, to plastics companies paying a higher price for raw materials, to workers with a higher cost of commuting.
Macroeconomic issues such as global demand, coupled with geopolitical pressures to adjust output, have reduced inventory levels, leading to higher market prices. Less oil = higher prices.
We drive by the virtual supply and demand curve every time we pass a gas station with a digital price on their sign. The price rises when the supply is low, causing drivers to drive less in order to save money. Less driving equates less demand and greater supply, causing the price to drop and the driving to increase.
Equilibrium means steady pricing, whether high or low.
Economic indices can aid contracts
For supply chain professionals, there is a wide range of public and private data and a vast amount of statistics and data analysis that will help inform business trends and patterns.
The Bureau of Labor Statistics (BLS) is by far one of the most import government sites there is. Full of relevant information and data to help manage the supply chain, it is also the home of the Producer Price Index (PPI).
The PPI is a family of indexes that measures the average change in selling prices by domestic producers of goods and services. The focus of data with the PPI is threefold: industry classification, commodity classification, and commodity based final demand, and intermediate demand (FD-ID).
The Consumer Price Index (CPI) is a market basket of consumer driven goods and service, a good tool to analyze pricing trends.
As not to penalize the buyer or seller, linking future contract costs to an index like the CPI or PPI is a fair alternative to poor performance, broken agreements and deteriorating relationships.
Supply Chain Dive
In addition to the PPI and CPI, BLS also publishes major economic indicators such as the Employment Cost Index, the Employment Situation, Productivity and Costs, Real Earnings, and U.S. Import and Export Price Indexes.
Supply chain professionals often use the PPI or CPI indices on contracts in an attempt to identify upward or downward pressure on supplier costs. During long-term contracts, there are economic and market forces that have a positive or negative impact on supplier costs.
As not to penalize the buyer or seller, linking future contract costs to an index like the CPI or PPI is a fair alternative to poor performance, broken agreements and deteriorating relationships.
The use of these indices, or other government data, is considered objective, not subjective criteria. By agreement, suppliers may raise or lower contract prices based on the agreed upon movement on the index, usually on a monthly, quarterly or annual basis, and often within an agreed upon percentage range. The key to this process is the ability to audit the price changes and maintain strong contract performance.
Additional macroeconomic data comes from the United States Bureau of Economic Analysis. Their focus is on macroeconomic issues such as gross domestic product (GDP), personal income, balance of payments, international trade and foreign direct investment.
This data is used to make long-term decisions and to understand long-term global economic trends. Familiarity with the BLS, the BEA, and also the Department of Commerce and the Department of Labor, offer macro and micro economics trends critical to supply chain professionals.
Using data as a business resource
The Institute for Supply Management’s Report on Business (ROB), a leading economic indicator, includes data on business activity, manufacturing production, new orders from customers, supplier deliveries, inventories, employment and prices.
This data, organized to support supply managers, provides general macro and micro economic data that will help in supplier negotiations.
Supply chain managers also have a responsibility to be internal business resources. Their direct access to a wide range of practical market intelligence through direct involvement in global supplier networks, coupled with access to original and curated economic data, creates the perfect opportunity to be internal company advisers to marketing, finance, operations and senior management.
Economics is at the core of managing the global supply chain. Those that don’t pay attention to the key economic indicators in their own business, in their commodity areas or with their critical suppliers, are at the mercy of market forces that may come to them as a surprise.
