What are the main drivers of supply chain costs?

Since founding Zengi Limited in 2015, I've had numerous opportunities to work with international clients in disparate industries. With an IT and Enterprise Architecture foundation, my focus has been delivering technology solutions for businesses. During this time, I have also toyed with starting ambitious and innovative projects in industries beyond my scope of expertise.

After years of helping others to develop business strategies, I have been intrigued by their supply chains. A supply chain is different in that it has a unique dynamic, many constraints, and lots of complexity. What I have noticed is there are some common challenges, the most significant being controlling costs.

The rising supply costs and the availability of resources and raw materials exacerbate global inflation. Why? Because supply chain costs constitute a significant and often hidden danger to the financial stability of an economy.

If supply chain costs are not effectively monitored, managed, and optimised, they eat away at a company's bottom line. If this remains unchecked, they will ultimately break your business.

The difficulties of cost minimisation

In the supply chain, cost minimisation is far from straightforward, requiring difficult decisions by stakeholders. Determining the cost drivers is fundamental to any cost-cutting initiatives.

Today, supply chains can be incredibly complex with many interconnections, so a cost reduction in one area can result in cost spikes in other areas.

Sometimes poor supply chain visibility means senior management is missing the costs their companies are amassing. They are unaware of the potential positive impact a minor cost reduction can have on their financial performance and competitive edge.

Understanding the interrelationship between various processes in your supply chain is paramount to understanding the impact of slashing costs in one area on the entire supply chain.

Senior executives focused almost exclusively on driving revenue growth are failing to assess the effect of their supply chain costs. This blinkered approach has the effect of causing irreparable damage to profit margins over the long term.

Five key drivers of supply chain costs

In my experience of observing supply issues, I have found the following key cost drivers:

Transportation Costs

The primary cause of higher transportation costs is inefficiency in the planning, routing and resource usage. For transport operations making strategic decisions is critical. Your supply chain network must consider supplier, manufacturer, distributor, and customer locations.

Optimising routes and transport methods and utilising third-party logistics (3PL) companies to handle extra capacity all need careful consideration. It may even be beneficial to consider the choice of suppliers, manufacturers, and distributors. Unfortunately, too many supply chain companies see transportation costs mushroom because they can't or don't consider all the variables.

Production Costs

More specifically, manufacturing can see production costs surge for many reasons. Primarily these are due to operational inefficiencies, such as poor utilisation of staff, production machines and other equipment.

Not being able to assess unit production costs, compare process alternatives and any potential benefit of investing in new technologies.

Protracted asset downtime and production lead times can decrease capacity.

Ineffective staff management can result in spikes in overtime, and production rework products create an issue for project-based or engineer-to-order (ETO) manufacturers.

There is, of course, an issue of utility overheads such as electricity, water, and equipment maintenance and repair.

Inventory Costs

Across the supply chain, companies rely on inventory as a buffer against supply and demand uncertainty and volatility.

Although appropriate levels of inventory give assurance a company can satisfy the demand but also be a source of excess costs. Stockpiling inventory can cause spiralling costs and tie up capital that might otherwise accelerate growth.

However, some inventory is necessary to satisfy demand. So, the goal is to reduce excess inventory and maintain sufficient stock of the right products in the right places at the appropriate times across your distribution network.

Procurement Costs

Choosing consistent, reliable suppliers who deliver the right products and materials at the lowest prices is vital. Getting the wrong supplier who is unreliable or too expensive can impact your performance and customer relations while pushing your procurement costs through the roof.

A company that optimises its procurement process ensures its ability to make the best supplier selections, which results in reduced procurement costs and improves delivery performance.

Investment Costs

Global businesses managing investment costs and making sound strategic investment decisions are critical. Doing this for the mid/long-term (5-10 years) requires an end-to-end view of the supply chain.

Developing strategic investment plans and making the best decisions requires accurate, data-driven demand forecasts and the capability to correctly calculate current and potential investment costs across your supply chain, with the ability to compare various what-if scenarios.

Conclusion

Of course, there are many routes to reducing supply chain costs, and in this article, I have outlined my opinion.

If you are serious about cost savings, you will need the capability to visualise and analyse your end-to-end supply chain. By using real-time and historical data coupled with forecasts and projections, you gain the ability to simulate different scenarios.

Armed with accurate management information, you can then develop a strategy for cost reductions that complement rather than conflict with your business goals.