The spectre of inflation reared its ugly head in 2022, just as the world was climbing out of the pandemic and looking forward to getting back to normal.
The interest rate increases by banks around the world, designed to reduce the rate of inflation, will continue to have impacts on Supply Chain across several dimensions.
Let’s discuss the various implications of these increase rate increases on Supply Chains everywhere.
Cash Flow
The first impact for companies and their Supply Chain concerns cash flow. Simply put, interest rate increases raise the cost of borrowing money. Very few companies have the level of cash only liquidity that allows them to fund their business operations from cash only.
Most companies maintain a level of cash reserves but also rely on borrowing at some level to fund their operations. Increasing interest costs must be funded, which reduces that cash position. Even though interest charges do not impact profitability from an EBITDA viewpoint, they do need to be paid and that comes from cash.
For many companies they may have the opportunity to pass those higher interest costs along to customers through higher pricing, allaying the cash flow impact. Even in a highly competitive industry there is a chance that customers have to accept those cost increases, as all suppliers will be in the same position. But where suppliers cannot pass those costs on their cash flow will be affected.
Operating Costs and Inventories
The second impact of higher interest rates will be on raw materials, operating costs and inventories. To the degree that companies are receiving higher costs, due to interest rates, from suppliers and operating costs, the cost of goods will increase as will the cost of carrying those goods.
Higher inventory carrying costs will, if costs cannot be passed on, cause companies to lower their inventory levels to contain costs. The problem with lower inventories is that we are still experiencing a long and ongoing list of shortages of goods (eg. cold medication) on store shelves and online in the face of higher demand, which lower inventories will only exacerbate. Higher inventory costs will ultimately end up being charged to consumers.
The same applies to operating costs. If companies need to streamline operations unnaturally (ie. not through productivity improvements) to contain costs, this will likely include restrictions on throughput and potentially supply shortfalls in the face of increasing demand.
One of the ways companies deal with rising costs is to shrink the size of their product packages while charging the same or even higher prices. We call this Shrinkflation!
Investments, or the lack thereof
Third, interest rate increases will impact the rate of Supply Chain investment. At a time of high demand, when companies need to invest in people, equipment and capacity, they often borrow the money to do that. Higher interest rates and carrying charges will cause companies to delay or curtail essential investment decisions.
Logistics
Fourth, there will be pressure on logistics companies, also impacted by higher borrowing costs, to pass those costs along. Increased capacity in the freight and logistics industry, along with extreme competitiveness and the ease of switching carriers, may cause logistics operations to absorb those costs in order to retain and gain business.
Talent Acquisition and Retention
And finally, with Supply Chain talent in high demand, and with people facing higher costs in their personal lives, acquiring and retaining this talent will require companies to pay more to their current and prospective employees.
Faced with higher costs of goods, increased mortgage rates, higher borrowing costs for personal loans, employees will seek out the highest level of compensation possible. At a time when the world now understands how important Supply Chain is the hunt for talent has never been more intense.
Conclusion
The reality is that costs never go down in the long term. Short term costs will certainly fluctuate. And year over year cost comparisons will likely show a lower rate of inflation between 2023 and 2022, as compared to 2022 versus 2021.
But Supply Chain companies will need to deal with the reality of these interest rate increases, either by taking steps to improve productivity, lower other costs, improve cash flow, lower inventory, or take the commensurate pricing action to pass costs on to customers.