Category Archives: Economics

Supply Management Economics Part II

In Part I, we noted that, as far as the doctor can see, the topic of Economics is too often swept under the rug where Supply Management is concerned. Why? Hard to say, but the recent failure of Macro Economics to predict the biggest downturn since the Great Depression and its continual inability to explain the tortoise-pace of the recovery is certainly a major factor.

But, reasons aside, the reality is that you can’t ignore economics. Not only will you be unable to judge a supply market strategy without a solid understanding of basic economic principles, but when you get down to the basics, as pointed out by Adam Smith in 1776, real wealth is resources and the goods and services produced with them. In other words, all wealth, and economics, revolves around Supply Management.

Remembering that the three basic questions of economics are what to produce, for whom, and how, we need a good understanding of the basics. The first understanding is the production possibility curve/frontier. This is a graph that compares the production rates of two commodities that use the same fixed total of the factors of production. The curve shows the maximum specified level of one commodity that results given the production level of the other. In other words, with fixed resources, there is a trade-off between how many units of each product can be produced. This is the basic theory that underlies your manufacturing planning.

The next understanding we need is that of comparative advantage. This is the ability of a party to produce a particular good or service at a lower marginal and opportunity cost over another. This is the basis of trade. This is because it’s advantageous to produce goods you can produce more efficiently than someone else and trade them for goods that you can produce less efficiently than someone else. In a more complex way, this is not only the basis for trade between nations but the consumer economy we have now.

To see this, we simply add IOUs into the equation. Let’s say you need shoes, but your skills are bookkeeping. Let’s also say that the shoemaker doesn’t need bookkeeping, but needs a hammer from the ironsmith. The ironsmith is poor with numbers and needs bookkeeping skills to keep the taxman off his back. In this case, the shoemaker can accept your IOU in exchange for the shoes and give it to the ironsmith who needs your skills. In this way, neither you nor the shoemaker have to fumble around for days trying to procure a hammer you don’t know where to get or produce one you don’t have the skills for, and the ironsmith doesn’t need to worry about the taxman as he can quickly produce the hammer the shoemaker needs who can quickly produce the shoes you need to walk to the ironsmith’s forge where you quickly do his books to keep the taxman away. When everyone does what they do best, and trade it, all parties profit. The only difference is that, today, instead of negotiating complex multi-party trades or passing around IOUs, we just use paper money issue by banks, which represent the value of the goods and services we trade.

In other words, when we understand the (multivariate equivalent of the) production possibilities curve and the concept of comparative advantage (which tells us that even if we can’t produce anything better than our competition, we can still profit as long as we produce something of value, although we will do better if there is something we are better at than anyone else), we understand how to determine what we should produce and in what quantity. And that’s the first step to successful Supply Management.

Supply Management Economics Part I

One of the goals of SI is to continually educate its readers on topics that other blogs miss or ignore. One of those topics that continually gets brushed under the rug is that of Supply Management Economics. For a while the doctor has been trying to figure out why. Is it because economics is not that important? Is it because economics is assumed to be implicitly conveyed in the topics covered? Or is it because there is no firm grasp of economics where Supply Management is concerned?

The answer is still up in the air, but part of the problem is obviously due to a lack of understanding, which should not be surprised when one considers that where the economy is concerned in general, there is a lack of understanding. Consider this recent article from the economist on A Brief History of Macro: How We Got Here about macroeconomics and its poor reputation these days due to its continual failure to answer why America’s post-crisis recovery has been so slow and, more importantly, its inability to predict the biggest and most powerful downturn since the Great Depression. (Epic Fail!)

Basically, despite all of economists’ grandiose claims to the contrary, when it comes to large-scale national and international economics, modern macroeconomic theory just doesn’t have a good enough grip on reality, so how can you be sure standard Supply Management economics is right either, even if you understand it? You can’t. But that doesn’t mean that you should ignore it either. There are a number of principles that hold up well and provide insight into the market dynamics that impact your organization on a daily basis. And without a solid understanding of the basics, how will you judge market-based sourcing strategies presented to you by consultants and experts? Before you can judge a supply market strategy, you have to know how much confidence you can put it in, and that requires an understanding of economics, the solidity of the underlying principles that are being assumed, and the assumptions that are unsupported.

In this series we going to cover a bit of the basics, as well as a few recent advancements in Supply Management Economic theory that may advance your understanding of strategic supply (relationship) management and inject more value into your value chain. We don’t know all the answers, but those who do not seek never find.

So where do we begin? At the beginning, or at least close to it. Back in 1776, when America was declaring its independence, Adam Smith, a moral philosopher and Scottish economist published An Inquiry into the Nature and Causes of the Wealth of Nations which offers one of the world’s first collected descriptions of what builds nations’ wealth. (Source: Wikipedia) In this fundamental work of classical economics, Smith essentially states that real wealth is resources and the goods and services produced with them.

Based on this, we are led to the three basic questions of economics:

  1. What to Produce.
  2. For Whom to Produce it For? And
  3. How to Produce It?

Which brings us back to my question of why economics continually gets brushed under the rug when Supply Management IS Economics!

You Can’t Buy Anything for a Quarter, So Why Do We Still Care About Them?

And more importantly, besides the fact that quarterly reporting pretty much became mandatory in North America with the Securities Exchange Act of 1934, why did we ever?

For those of you that are lost, I’m referring to the fact that when you focus on a quarterly number, you often screw up the year, or, as demonstrated in some recent research by the REL Consultancy, a Hackett Group Company, the next year. As summarized in this recent Industry Week article on how It’s All in the Game When It Comes to Year-End Cash Management (among others), attempts to game the system and post good fourth quarter results by delaying payment, manipulating receivables, or offering deep customer discounts just to book last-minute sales always lead to first quarter losses in the subsequent year that exceed the gains in the fourth quarter.

Specifically, the research indicated that while working-capital performance improved by 10% in 2011 Q4, it dropped by 11% in 2012 Q1. In other words, the loss exceeded the gain by 1%!

We’ve become way too focussed on the short term and the year end. What’s important is the long term. Given the choice between a 5% gain today and a 15% gain in a year and a 10% gain today with a guaranteed loss of 5% in a year, a company should always choose the first option as it gives the greatest combined gain over two years. But today, most public companies will choose the 10% gain today, turn a blind eye to the impending loss, and, if pressured, mumble that “we’ll figure it out later”. The problem is, if the gain comes at the expense of a deep discount on maintenance and labour rates are skyrocketing, at the expense of putting off needed upgrades to energy hogging equipment when energy costs are skyrocketing or delaying payables when interest costs are mounting, there’s no way to figure it out later. Cost are going to go up and losses are going to mount.

Not only do companies have to start managing working capital on a year-round basis, as the article notes, but they have to start managing growth on a long-term basis and re-instate the five and ten year plans as one to two year plans just aren’t enough. If this means they have to f*ck Wall Street and go private, so be it. Until we abandon this success today at all costs mindset, we’re never going to take supply chains to the next level.

Risk – The More Things Change, The More They Stay the Same IV – Economic

In our last post, we discussed the top geopolitical risks facing your Supply Management organization that were chronicled in the World Economic Forum‘s 7th annual “Global Risks” report. Chronicling dozens of risk divided into five categories, this report did a tremendous job of covering the types of risk that an average Supply Management organization needs to prepare for. Today, SI is going to continue its coverage of the report by discussing the top risks from an economic perspective.

From an economic perspective, there are four major risks. These two major risks are exactly the same as last year:

Extreme Energy & Agricultural Price Volatility

Today’s organizations are ultimately dependent upon three things – people, raw materials, and the energy required to transform the raw materials into the product the organization will sell. If oil doubles in price, that could make the difference between being able to produce the goods in China and import them into the US for sale at a profit and having to import them into the US for sale at a loss (or risk losing the entire inventory). And food prices in certain categories have been approaching, and reaching, all-time highs ever since reserves hit all time lows since World War Two last year.

Fiscal Crisis

The fiscal crisis can lead to many things – currency volatility, a credit crunch, and overall infrastructure fragility. Weakening currencies can cause costs to skyrocket. A credit crunch can severely restrict cash flow and make it almost impossible for an organization to temporarily borrow the cash it needs to secure the inventory required to produce the goods it plans to sell to create revenue and, eventually, generate profit. And infrastructure fragility, which weakens every time there is insufficient cash to invest in necessary maintenance, can result in transportation lanes, power plants, and basic utilities becoming unavailable overnight. The ramifications of a fiscal crisis can reach far and wide.

These two risks have increased in severity since last year:

Chronic Fiscal Imbalances

Government debt obligations are rising out of control around the world. The recent government debt-crisis in Greece, which followed the bankruptcy of Iceland in 2008, could be just the beginning. With the US at its fiscal cliff, the UK increasing public sector and private sector debt at an alarming rate (while net assets are falling), and general government debt in Japan projected to reach 245% of GDP in 2013, this risk is getting extreme across the developed world.

Severe Income Disparity

The rich are getting richer and the poor are getting poorer, and this is true in the developed world and the emerging world. The recent occupy movements have brought to light how the top 1% receive almost 25% of the income in the U.S., reaching a high not seen since 1928 (just before the Great Depression). The gap between the rich and the poor is rising rapidly in China, where approximately 10% of the population live below the global poverty line (which is really, really low). And this trend is continuing around the world. This is scary as many revolutions throughout history have been based on the economic inequality between the rich and the poor.

CASSH starts with Canada!

Wall Street is about to go gonzo again and you can …

Blame Canada! Blame Canada!

With all our beady little eyes
And flapping heads so full of lies

Blame Canada! Blame Canada!

Time to form a full assault
It’s all Canada’s fault!

Yes, it’s all our fault. Because of our strong risk aversion and sound fiscal and financial management policies (with the exception of any policy Harper wants to implement), we are emerging from the global financial crisis in a comparatively healthy state. We don’t have a fiscal cliff, a systemic debt crisis, grossly unbalanced budgets or high levels of unemployment. We tend to make good policy decisions (with the aforementioned example) and, as per this recent article on CNN Money, we have “hidden value” (Dec 3, 2012).

And, like the other CASSH countries (Australia, Singapore, Switzerland, and Hong Kong), we’re looking at a 3% increase in GDP in 2013, compared to the 2% expected in the United States and Japan and the 1% in the EuroZone. We’re becoming the GDP leaders of the developed world! We’re stealing your thunder! (That’s right, you’ve been ThunderStruck.)

So what does this mean? For those of you South of the border, it’s time to take a closer look at your northern neighbour for investments of all kinds. Need a new R&D lab? Put it here! (And maybe even save some tax dollars while you’re at it. You can save Millions in taxes with SR&ED if you qualify, for example.) Need a new high tech manufacturing facility? Put it here! (And in addition to our productivity gains, take advantage of our highly educated workforce – our University completion rate is over 25%, meaning over 1/4th of the population between 25 and 64 has a degree.) Need a new corporate headquarters? Put it here! (Our banks won’t go bankrupt and take your cash with them!)

And, again, you can:

Blame Canada! Blame Canada!
It seems that everything’s gone wrong
Since Canada came along

Blame Canada!
Blame Canada!
We’re not even a real country anyway

:-;