The latest U.S. employment report seems to have given the Federal Reserve a strong signal to bump interest rates after it failed to do so in September. Employment increased by 211,000 people following a gain of 298,000 in October that was bigger than previously estimated, easing concerns that manufacturing activity is slowing.
While the interest rate increase is expected to be modest, it will have an impact on procurement activity and supply chain finance. Before looking at the impact of raised interest rates, let’s look at the impact of reduced loan availability a few years ago and extended payment terms–stretched from 90 to 180 days in some industries. These extended terms have fueled a booming factoring market where suppliers sell their receivables at discounts that are far higher than loan interest rates to maintain cash flow. Not only is the sustainability of this practice in question, but it becomes difficult for a company to compute true days sales outstanding. So, can the supplier who factors or the buyer who relies on liquidity calculations as part of risk management really know where the company stands? Higher interest rates will not help a company stop this sell-receivables-today-to-fund-new-sales-production cycle.
We have become comfortable with low cost money and when that cost is increased, it will have a serious impact on low margin, high volume suppliers who are essentially financing the supply chain for the end customers. Labor costs will likely be impacted as the cost of credit cards, hard goods, homes and automobiles carry the increased interest rate cost to the consumer and workers will look for higher wages.
While the interest rate hike will not be a surprise, the market change from a buyer’s market to a seller’s market may catch some procurement and supply chain professionals by surprise, who in many have not lived through periods of inflation and increasing prices.
While I hope that the impact is minimal, I am advising all of my clients to complete a financial risk assessment of their supply chain, dust off cost containment processes, retrain their teams and review all contracts.
In times of uncertainty, its always best to drive a proactive approach.
10 tips to control costs
This WSJ headline caught my attention: Fed’s Fischer: ‘Good Reason’ to Think U.S. Inflation Will Move Higher. Vice chairman says Fed shouldn’t ‘wait until inflation is back to 2% to begin tightening.’ This should serve as a warning to all companies that the good times may be nearing an end and we may be experiencing the switch from a buyer’s to seller’s market.
Should interest rates rise, many suppliers and supply chains will feel the significant impact of severely extended payment terms. We’ve been working in an economy where the cost of money is relatively low; as interest rates rise, suppliers and the entire supply chain will be impacted by added costs to support the extended terms. As these costs increase, there’s an additional risk that the front-end of the supply chain may not be able to fund or pass through increased costs, causing severe supply chain risk.
Sourcing practitioners have basically two options for dealing with cost containment: wait until the supplier increases the price, then react, or proactively create a cost containment plan that involves the entire organization.
Good proactive cost containment plans require these 10 actions:
- Improvement of functional inter-site and intra-business collaboration
- Monitoring external markets and market pressure for price increases
- Forecasting the impact of potential price increases on the business
- Reviewing all contracts to solidify current pricing and prioritizing cost containment targets with quantified objectives
- Researching market and supplier data
- Building a supply chain map
- Running risk assessments on the supply chain
- Conditioning suppliers against price increases
- Building tactics for delay
- Deterring price increases
I have been around long enough to experience cycles of inflation and these actions have been proven successful when dealing with inflation. The difference today with the inflationary periods of the past are that the extended payment terms across the supply chain make some of the suppliers extremely vulnerable to the increased cost for money.
Sometimes forecasting the economy is like using a Ouija board, but all signs are pointing to interest rate hikes, hence, inflation. So, should you wait? I see it like this, borrowing a quote from Clarence in It’s a Wonderful Life, “You see, George, you’ve really had a wonderful life. Don’t you see what a mistake it would be to throw it away?”
Are you ready for a Seller’s Market?
Setting your strategy through 2016
In today’s economic environment, how should procurement professionals look at the market?
Let’s review the forecasts. Most economists are forecasting growth through 2015 and accelerated growth through 2016 with leading forecasters predicting that the world economy will grow between 2.8 and 3.0%. Looking at the October 2014 forecast of the International Monetary Fund (IMF), world growth was measured at 3.3% for 2014. There is little doubt that the US is leading the way with strong performance and lower unemployment numbers. However, while Janet Yellen sees “some of the headwinds that have been holding the economy back are beginning to recede” and sees a possible interest rate hike in as a sign the economy is healthy, what impact will a possible June interest rate increase have on the tricky financial supply chain?
As I review these numbers, consider the decline in oil pricing, increase in consumer spending and predictions of a strong global economy, I am placing my bet that the buyer’s market of cost containment, available supplies and increasing volumes back to pre-recession levels is here for a while, even if interest rates start to raise this summer.
Buyer’s market is great news as procurement professionals prepare plans for 2016. It’s always a challenge and worry when setting standards and budgets, but it looks like buyers can go forward with a great deal of confidence. Understanding the macro and microeconomics is an essential skill required by any purchasing professional.
Go forward with some confidence and capitalize on the buyer’s market as long as you can.
Make hay while the sun shines.
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Tagged budgets, buyers, cost containment, economy, energy costs, fuel costs, fuel prices, interest rates, oil prices, prices, procurement, purchasing, sourcing strategies, supply chain