More Inflation Cautions

The Institute of Supply Management’s Purchasing Managers Index (PMI) for October that was reported today made its biggest jump since 2006. — from 52.6 in September to 55.7 last month. (See the news release.) That’s good news for the economy as a whole, but it bolsters our cautions that pressures on prices are likely to increase faster than the pace of economic recovery over the next few months.

The PMI is considered a leading indicator of economic business conditions. Purchasing managers are already reporting price increases in 11 commodity categories. Furthermore, inventories have been contracting for 42 consecutive months. Those facts suggest that price pressure is likely to go up.

Suppliers may be trying to recover from their losses over the last year and perhaps betting that shortages might drive prices higher quickly. It’s also possible that tight credit is still limiting manufacturers to add production capacity. Whatever the reason, buyers must remain diligent in their efforts to contain cost.  As companies recover and work to improve their bottom line, cost containment will be the core focus in managing suppliers in 2010. It will be necessary for buyers to review their tools for containing costs and develop new methods for dealing with price escalation.

In southeast Michigan we see the same kind of pressures on prices, but there was also a drop in the local PMI, released by the Institute of Supply Management – Southeast Michigan.  The ISM-SEM reported that its October purchasing managers index was 51.3, a drop of more than 10 points, but still in the range that demonstrates some modest improvement in economic conditions. The three-month trend of the index also remains positive.

We likely had an uptick in September as a trailing result of the ‘Cash for Clunkers’ automotive incentives. The October composite figure shows a slight cooling off, but looking deeper we see local purchasing managers reporting higher prices in a number of categories. That suggests there is finally demand building that can drive new growth.

The drop in the southeast Michigan index might suggest a note of caution about the national figure, too, because Michigan’s PMI often leads the index for the rest of the country. October’s big jump in the national PMI might be followed by a lower index next month, matching Michigan’s pattern. With so many uncertainties, we shouldn’t be surprised if the recovery has some fits and starts. Overall the outlook is still positive.”

Damage Control = Cost Control

We were thinking here about how Wal-Mart wants to eliminate all returns from its suppliers over the next 2-3 years and it reminded us that even though you expect the carrier or supplier to cover the cost of damaged products — it still makes sense for buyers to take an active role.

Here’s what our consultant Fred Parkinson had to say on the matter.

When products or merchandise that arrive at your loading dock damaged – what do you do? Could the damage have been prevented? What are the actual costs, both direct and indirect, of managing product that has to be returned or discarded?

Prevention 

OK, you can’t control weather or sloppy package handlers, but you can write packaging specifications into your product orders. Purchasing should call on other departments within the company to help develop specifications and shipping requirements that will insure the integrity of the product when it arrives from the supplier. 

Your supplier should also be used as a resource to develop the packaging and shipping requirements because they likely have dealt with damage returns in the past.

Your parts supplier may guide you to its corrugated supplier, who will likely have a packaging engineer or designer whose services would be available to you free of charge. 

The transportation carrier should also be able to provide or recommend shipping solutions that will get the product to your dock without being damaged. Maintaining good supplier relations will help you in times like these when you need to draw on their expertise.

Costs

The hidden costs associated with returning damaged product may include:

·      Warehouse labor costs, both at your facility and at the suppliers plant, that result from handling the damaged goods three or four times.

·      Administrative labor costs of notifying the supplier of the problem, submitting claim forms with the carrier, arranging for pick ups and expediting a replacement shipment.

·      Inventory costs associated with carrying a larger safety stock if the problem is a reoccurring one.  If the product is being imported the pipeline will be substantially longer, which will also have a big impact on how much safety stock has to be carried.

·      Accounting labor costs to process and handle multipliable invoices and credit vouchers.

·      Cash flow issues while claims are being settled or waiting for credit.

·      Lost sales revenue from being out of stock and customer dissatisfaction which may result in loss of business long term.

All good suppliers and carriers will cover the obvious expenses, but when you calculate these hidden costs – you can see why it’s in the interest of buyers to take active steps to prevent damaged goods from arriving at their plants.

 

Roller coaster diesel prices may be masking a new carrier pricing cycle

They took off like a rocket and fell like a stone. The spike and subsequent plunge in diesel prices over the last six months has quieted many analysts who are normally quick to give you a prediction of fuel costs. Roll in the unknown effects of a global credit freeze, a stock market free-fall and you have a shipping environment unlike anything we have seen in the past.
David McClimon, who has spent over 28 years in the transportation industry and most recently ran Con-way Freight, is now advising some of our clients on their transportation and logistics issues. I asked him to contribute to this blog, and here’s what he had to say….
——
Before the spike, carriers had been chasing a declining level of tonnage, keeping rates low. During the price spiral, fuel surcharges swung the price pendulum emphatically the other direction. As fuel prices came down, common wisdom would expect the pressure to keep rates down would exert itself again. This seems especially true as shipments in core industries such as auto have dropped dramatically. In short, any company that is still shipping should be in the driver’s seat on prices.
Before we all celebrate too much, though, there are warning signs ahead. The surge in diesel fuel prices put many marginal carriers right out of business. According to America’s Commercial Transportation research group, more than 45,000 vehicles, or 3% of the tractor fleet, have disappeared from the industry since last year. Carriers with at least five trucks are going out of business at an accelerated pace. The American Trucking Association reports that in the first quarter of 2008, 935 operations shut down. This is up from 385 in the first quarter of 2007 and is the highest quarterly failure rate since the 2001 recession.
Don’t expect the contraction to end quickly, either. There are analysts projecting truck capacity in the U.S. to drop at a rate of 2% per quarter, or 6% by mid-2009. Add that to the number already gone and we might have a total capacity loss of more than 10% over an 18-month period.
When the economy turns, capacity is not likely to come back as quickly as demand, and prices may rise accordingly. Of course, no one is ready to predict the timing or the pace of a turnaround, so there is considerable uncertainty in the market.
Whenever uncertainty is high, risk is also preeminent. Here are some ways to mitigate risks if your business expects to survive this recession and capitalize on a recovery:
1.    Be sure your fuel surcharges are current – based on latest, falling prices. With barrel prices collapsing a week’s change could be a big change.
2.    Assess the financial health of your most important carriers. Do they have the resources to deliver right through a recession? Failure of a strategic supplier could disrupt your supply chain during a downturn. Weigh the benefits of leveraging now with the risk of losing the low-bid carrier to bankruptcy and the cost of lining up new carriers when the capacity is scarcer and carriers have the upper hand.
3.    If you see an opportunity to take advantage of current overcapacity, do so carefully. Evaluate each situation individually. You might be able to lock in long-term base rates that make you look very good in 18-months, but only if your carrier is still in operation. There is no good reason to leverage your current advantage into a supplier failure.
In summary, look through the wild swings of fuel surcharges to the fundamentals that are still at work in logistics. Don’t get caught up in driving prices down unless you have carefully assessed your supplier.
Establish relationships, because if you plan on being in business 18 months from now, you want your primary carriers to be in business as well. Those shippers that have been able to develop long lasting relationship with their carriers, vs. taking advantage of short term pricing pressure opportunities will be in the best position when the power of the pricing pendulum swings in favor of the carrier.