Basic Training: Oil prices change the calculus of offshoring

Several eons ago, when traffic managers had yet to morph into logisticians or worse, supply chain managers, an epidemic of just-in-time (JIT) initiatives swept across the planet. It's not hard to understand what managers of the day found so appealing about JIT (which emphasizes lean inventories with frequent replenishments). In an era of easily available and inexpensive fuel, the inventory savings easily offset the costs of added deliveries. Businesses of all stripes jumped aboard the JIT bandwagon.

At about the same time, we saw the rapid shift of sourcing to suppliers far afield—generally to the Pacific Rim, but always to low-labor-cost countries. Of course, that movement, too, was predicated on the ability to move vast quantities of goods incredible distances with low-cost fuel.

But as the outsourcing movement gathered strength, the price of crude oil also began to move. Actually, it began to gallop. As the price of crude approached $150 a barrel, the notion of $200-a-barrel oil—once unthinkable—no longer seemed preposterous. And no one snickered anymore when $500 was floated as a possibility or scoffed at warnings that oil might someday be unavailable at any price.

Overnight, it became permissible to talk about the foundational things that were wrong with long-distance offshoring. It was no longer necessary to whisper about inadequate and unreliable infrastructures, corrupt officials, the vulnerability of intellectual property, currency manipulation, and the like. They'd always been weaknesses, but low unit costs had a way of blinding the eyes to reality.

All this has left companies struggling with decisions about how to proceed in the face of escalating transportation costs. In the abstract, bringing the work "home"—and soon—is the obvious response. But the solutions are not always as simple as firing up the furnaces in the ol' home town. The furnace might have been sold for scrap. The skilled workforce has likely retired or left the area for other jobs. The suppliers might have folded between then and now. Where—and in what condition—are the molds, forms, patterns, and dies needed?

So, many times, other options get considered. But which ones are right? Can the local capability be rebuilt? Is finding a nearly-as-low-cost producer—only not quite so far away—an answer? How about shifting to another U.S. location? Or better yet, could nearshoring to Mexico or the Caribbean make the proposition work? Or are there third parties somewhere in North America who could take on the job?

And the answer is ...
These are all good questions. Unfortunately, there isn't any answer, at least not a one-size-fits-all solution derived from a standard template. Everyone's circumstances are different. For instance, one company might decide that the transportation savings justify the expense of relocating production to Mexico, while another might decide it's better off sticking with its Asian producer for lack of reliable alternatives.

But in the end, the biggest problem of all may be the volatility of oil prices. Although prices have retreated from their July 2008 highs, there's no assurance that crude prices will remain stable. They could jump up to previous highs—or higher—without warning and for no particular reason. Today's right answer can easily become tomorrow's financial albatross. And a solution predicated on $150 oil may look like a self-inflicted wound when prices drop.

The crux of the issue is that prices—driven by demand, speculation, and frivolous machinations by producers—are likely to continue to yo-yo. So, what's the sensible course? The certainty of a solution that looks superficially bad, or the uncertainty of a solution that's sometimes excellent and sometimes horrendous?

What's your tolerance for cost uncertainty—and what is your management's? What customer and service impacts are probable in an uncertain sourcing and transport world? And how might those uncertainties affect customer loyalty and retention?

Tugging on the supply chain
We tend to think of these issues in terms of manufacturing, but their impact is far greater in scope. As supply chain managers, we are going to be tagged with much of the responsibility for how they are handled.

Today's dilemma hits the sourcing function squarely between the eyes: Where to go? If, when, and how to come back? And where to come back to, if at all? All with cost consequences that can make the benefits of years of supplier cost-reduction initiatives disappear overnight.

That doesn't even begin to consider the time and cost implications of marine transport from Asia versus the Caribbean Basin. Or the need to get product from point of entry (either water or land) into a rational distribution network. Both of these add time and cost factors that didn't even figure into the equation back when the goods were still made in the USA.

Then there's the critical question of whether—or not—distribution centers are both correctly placed and correctly sized to handle whatever the latest solution is. With that comes a set of decisions regarding capital requirements to meet new demands—or a re-evaluation of the role of logistics service providers in the new model (along with their ability to change as fast as the next solution emerges).

Supply chain managers have always been somewhat at the mercy of factors beyond their control. Once upon a time, though, you could expect that variation would lie within a somewhat predictable range. With the evolution of global competition for finite resources, that has changed forever.