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What Is the Supply Chain? Why Is It Important?

Buyers of clothing, laptops, and cars (to name a few) don’t usually think about the steps involved into getting the product into their hands until there’s a disruption.
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Image of a cargo ship with text overlay "What Is the Supply Chain?"

Supply chains are the networks and systems that facilitates the resource extraction, production, manufacturing, transportation, and sale of goods worldwide. 

What Is the Supply Chain and How Does It Work?

We live in a global economy, powered by a complex network of resources, materials, manufacturing, and transportation, which work together to bring products and services to customers. This is known as the supply chain.

The supply chain is made up of a variety of players ranging from locally based raw material suppliers to large, transnational corporations: Each plays a role in the creation and distribution of the products that fuel everyday life, from the clothing we wear to the roofs above our heads to the food we consume and the chips that power our electronics—to name just a few.

How Was the Supply Chain Constructed?

The supply chain has been around since the Industrial Revolution, but there have been key developments in recent history:

  • World War II is to thank for many breakthroughs in logistics, since weapons and supplies needed to get to troops both quickly and efficiently.
  • After the war, there were other advancements, such as the invention of the storage pallet, which allowed goods to be consolidated and stacked vertically, and the shipping container, which can be moved by boat, truck, and railway car, enabling perishable items to be transported across great distances quickly—and saving both time and money.
  • The expansion of global trade in the 1980s, especially the rise of manufacturing in Asia, created a global division of labor and lowered prices for goods.
  • International trade agreements in the 1990s allowed countries to exchange products as well as raw materials with each other freely, building quite a web.

What Is Supply-Chain Management? What Do Supply Chain Managers Do?

True to its name, supply-chain management makes sure all of the moving parts needed to create a finished product are running smoothly. This includes:

  • Storing the raw materials needed to create a product
  • Sourcing cost-effective manufacturers
  • Assembling basic parts into finished products
  • Warehousing products until they are sold, and
  • Delivering the products to consumers

A supply-chain manager’s job is to maximize efficiencies and prevent shortages. They manage inventory, production, sales, and vendor and customer relations in order to increase profits. For instance, a supply chain manager could develop a strategic partnership with a vendor or lower production expenses by purchasing directly from the source.

Why Is Supply Chain Management Important?

Supply chain management is a critical component to any business’ success. It is important because it can reduce a company’s operating expenses and thus increase profitability.

What Are Some Types of Supply Chain Models?

There are several different kinds of supply chain models, and each business should choose the one best designed for its needs:

  1. The continuous flow model is designed to produce a steady cadence of the same product in high demand, usually for a well-established company. There is little modification to product design here. This model is all about maximizing efficiency. An example of this would be commodity manufacturing.
  2. The fast chain model is built for responsiveness. It’s used for trendy products with short lifecycles. Manufacturers who change their product lines quickly—and can be the first to hit the market—are the ones who win big here. Think apparel companies, like Nike, who can sell mass volumes of a particular design before it goes out of style. When the next trend comes along, they develop a new supply chain around it.
  3. The efficient model is designed for competitive businesses that need an “edge” to get ahead, whether it’s through inventory management, production output, or delivery logistics. The breakfast cereal market is an example of this: Products are very similar, and manufacturers sell to the exact same audience, so a cereal company like General Mills must figure out how to reduce costs, either along the supply chain or among its suppliers, in order to gain an advantage.
  4. Everything about the agile model is made to provide a cost-effective response to what customers want. Companies that follow this model don’t mass manufacture products; rather, they might have a base product that can be customized quickly to meet specific demand. The “copycat” clothing manufacturer, Zara, is one example.
  5. The custom-configured model differs from the above models in that it centers around small batches of specialty products. This model requires greater setup time and produces products in limited-edition quantities. An example of this would be a furniture company that lets consumers choose finishes, design styles, etc.
  6. One model that strives to be the best of all worlds is the flexible model. Because of its flexible planning strategies, it can respond to high volume demand at peak season and survive long periods at low demand. An example of this would be the office supply store, Staples. It anticipates increased volume during the back-to-school shopping season but also uses seasonal contracts with suppliers, along with stocking algorithms, to lower production levels the rest of the year. 

What Is Behind the Current Supply Chain Issues? How Does the Supply Chain Impact Inflation?

The COVID-19 pandemic created a global tangle of disruption. Although vaccinations lessened the severity of the virus, the supply chain logjam became even more twisted in early 2022, when new, vaccine-resistant COVID-19 variants were discovered, and a war erupted in eastern Europe. These factors led to production and transportation issues in both food and energy supply chains, which resulted in higher prices—and whenever there’s an increase in prices, inflationary pressures are felt in the economy.

Let’s take a deeper look at each factor:

The COVID-19 Pandemic

The COVID-19 pandemic underscored the importance of a resilient supply chain. When the pandemic began, businesses with complex supply chains were hit especially hard as restrictions shuttered operations, sending workforces home. Borders were closed, which prevented raw materials and product shipments from entering countries.

Consumers who were stuck at home changed their buying habits, and businesses were left with billions of dollars of unsold goods, causing inventories to rise. However, as soon as stay-at-home restrictions were lifted, demand spiked, yet inventories were not able to be replenished quickly enough due to ongoing bottlenecks.

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One example everyone remembers has to do with toilet paper. The White House estimates that stay-at-home orders caused a 40% increase in demand for retail toilet paper, which is softer than the kind used in restaurants and offices. Suppliers usually only keep 2-3 weeks’ worth of retail toilet paper inventories on-hand in their warehouses, and so when demand skyrocketed, they simply could not satisfy it fast enough.

Similarly, automotive makers witnessed a decrease in demand at the outset of the pandemic and canceled orders of semiconductors, which require a long lead time. Cars are made of steel, rubber, plastic, and semiconductors, which all have their own web of supply chains, and so when demand returned, further delays ensued.

Other sectors affected by the pandemic included the housing market, which was devastated by an increase in commodities prices—spiking as high as 20%. The cost of framing lumber needed for a 2,000 sq foot house, for instance, jumped from just $7,000 in 2019 to more than $27,000 in 2021.

China’s 2022 Lockdown

In early 2022, the city of Shanghai experienced the most widespread COVID-19 outbreak since March 2020, based on the Omicron variant. From February 28 to June 1, 2022, Chinese authorities placed the entire city of 25 million, along with neighboring cities, under a lockdown. China has long held a “zero-tolerance policy” for COVID-19 but had been a bit more lenient with Shanghai, since it was an important manufacturing center as well as the world’s largest port.

Multinational companies with operations in China—, like Apple, which has assembly plants in Shanghai—were hammered. Amazon also operates out of Shanghai, and Adidas made the city its Chinese headquarters in 2017. Not only did the lockdown affect manufacturing, but it also impacted 2022 consumer sales—by as much as $4 billion in Q2 for Apple alone.

Now that the lockdown has ended, some manufacturers, like Volkswagen and Tesla, have been authorized to restart production, although it will take some time to reduce backlogs. The lockdown also snarled traffic for up to 20% of the world’s container ships, as they literally sat for weeks, waiting for their cargo to be offloaded. Some analysts believe shipment delays will be felt as late as 2023.

Russia’s Invasion of Ukraine

Russian President Vladimir Putin announced the Russian army’s invasion of Ukraine on February 24, 2022, saying his aim was to “demilitarize and de-Nazify Ukraine.” In the subsequent months, Russian military forces destroyed cities in the east part of the country, killed thousands of citizens, and displaced millions more.

This part of the world is rich in natural resources—its wheat products are used to feed developing nations, and its raw materials, like palladium and neon, are important components in semiconductors. Russia’s response to Western support of Ukraine was to cut off gas supplies to Poland and Bulgaria, which halted shipments of commodities, causing prices to increase even further.

More importantly, Russia is one of the world’s biggest oil suppliers, and the invasion resulted in the loss of supplies of 3 million barrels of oil per day, which pushed prices higher than $4 per gallon in the US. However, President Biden promised to tap strategic oil reserves in compensation.

The war has also tangled transportation logistics, which now face disruptions in the Black Sea, air restrictions over Russia and Ukraine, and freight issues across Eastern Europe. The whole world waits to see what will happen next.

Is There a Silver Lining?

Before you think the global supply chain is snarled beyond repair, there is some hope: The most recent reading from The New York Federal Reserve’s Global Supply Chain Pressure Index (GSCPI) reveals that pressures declined in May 2022, and its three-month reading indicates that they may have actually stabilized.

This index factors in data from a variety of sources, including backlogs, freight issues, and delivery times, and stretches back to 1997. Changes in pressures are associated with producer price inflation in the United States, making this dataset useful to watch. We look forward to seeing if a peak has occurred.

The GSPCI is released on the fourth business day of every month; the next index will be published on July 6. 2022.

GSCPI

How Will Supply Chain Issues Be Resolved?

Throughout globalization, a business’ main objective was to maximize efficiencies. Most companies did this through an inventory management method known as “just in time,” which allowed them to receive goods from suppliers only when they were needed.

Now, as shocks from pandemics, climate change, and war create mass disruption the world over, companies are acknowledging that they need to take delays into consideration through their strategic planning processes. They can do this by identifying the weak links in their networks and prioritizing digital technologies, which might alleviate the need for human drivers.

Their aim has now become the creation of “just in case” backup systems, which guarantee a minimal level of supply during times of crisis. This method involves a greater reliance on robotics, AI, and machine learning.

Are the Terms “Supply Chain” and “Logistics” Interchangeable?

Logistics makes up an important part of the overall supply chain, but the two terms are not interchangeable. The term “supply chain” encompasses much more than logistics and also includes activities like manufacturing and delivery.

What Does Transparency in the Supply Chain Mean?

Transparency is an incredibly important part of the supply chain, and fortunately, most companies pledge to be socially responsible in their business practices in order to be accountable to their customers. How do they achieve this? By making sure their suppliers are acting according to legal and ethical standards in terms of raw material extraction methods, labor practices, and product pricing, to name just a few.

When Will Supply-Chain Issues End? Which Supply-Chain Shortages Are Coming?

TheStreet.com’s Dan Weil has identified five factors to watch to see if supply chain issues will resolve in 2022.

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