At the height of the COVID-19 crisis, with the world going into lockdown, manufacturers struggling to secure raw materials and other key supplies consoled themselves with the conviction that the pandemic would be a passing phenomenon. Unfortunately for them, that hasn’t been the case. Few organizations have worked out how to cope; they are simply not set up to deal with the new commercial reality.
Simply put, the world has become less predictable. COVID-19 was followed by war in Ukraine, which caused new kinds of supply chain disruption, with conflict in the Middle East exacerbating such problems. Extreme weather conditions related to climate change have added to the crisis. Political tensions and protectionism are driving governments to impose stronger import and export controls. The list goes on.
As a result of such unprecedented exogenous forces, many businesses find themselves pushed into uncharted territory. Familiar business problems such as slow demand are not the issue; rather, it’s the breakdown of supply chains that is preventing them from fulfilling that demand and thereby constraining growth.
Take the automotive industry, where manufacturers such as Tesla and Volvo were forced to halt production last year in some markets because component supplies were being adversely affected by attacks on shipping in the Red Sea. Recently, the opposite is happening with Tesla reporting disappointing sales. Or consider the supermarket subsector, where UK stores ran out of fruit and vegetables during 2023 after adverse weather across Europe hit producers.
In the pharmaceuticals industry, businesses such as Novo Nordisk and Elli Lilly have been unable to secure the capacity needed to meet demand for weight-loss drugs. The shortage is so acute that supplies have run short for patients in critical need of such treatments. In the technology sector, businesses working on artificial intelligence (AI)-powered software and hardware report they are short of required semiconductor supplies.
“In this world, the customer is everything. Every corporate system is focused on ensuring the business can deliver what customers want.”
It wasn’t supposed to be this way. For more than 60 years, most companies have operated to a familiar template, seeking to sell as much as they can and to increase their customer bases. Sophisticated demand forecasting models could forecast with a good degree of accuracy how much customers were likely to buy; all businesses had to do was to make sure they had enough product to meet this demand.
In this world, the customer is everything. Every corporate system is focused on ensuring the business can deliver what customers want. This is the whole point of a modern enterprise resource planning (ERP) system: you tell your ERP software what you expect customers to buy, and it will come up with a blueprint for how to meet that demand, from procurement to production.
However, companies that want to ask their ERP systems a question unrelated to meeting customer demand are likely to be disappointed. Ask the computer how to manage with a limited supply of ingredients or components and there is unlikely to be a meaningful answer. ERP system designers never conceived of a world in which lack of supply, rather than low demand, would be the limiting factor in the value chain.
The result is a mismatch. Industry can’t produce enough cars for consumers who want to drive the latest model or keep up with demand for drugs that help people keep their weight down. There may not even be enough fresh produce to go round. Nor do businesses have any idea how to share out what they do have. A new sales strategy is required.
“Supply chain disruption almost always leads to price increases, for example, but businesses can protect their best customers by absorbing some of the cost increase themselves.”
In this new world of ongoing supply chain disruption, with demand significantly exceeding supply during some periods, there inevitably has to be some rationing. The question is, which strategy to employ and which criteria to apply in deciding on a rationing structure.
Naturally, there is no one-size-fits-all answer to that question – every organization is different. But the criteria will broadly fall into three categories.
The most tempting solution for any profit-making organization is to ration products according to ability to pay and gross margin. If there isn’t enough to go round at the current price, the simplest answer may be to raise prices to a level where demand and supply coincide. Effectively selling to the highest bidder in this way delivers the happy by-product of extra revenue.
Second, organizations could opt to take a longer-term approach, prioritizing customer demographics strategically based on potential future sales. The priority group might include the most loyal customers, who have consistently spent money with the business over a number of years, or customers that buy regularly in bulk and therefore provide a predictable income stream. These, after all, will be the customers the business wants to retain for the long term. An approach based on short-term gains might ultimately prove self-defeating if it alienates the core customer base.
The third set of criteria that come into play could be described as ‘contractual obligations.’ The business may have ongoing contracts to supply certain customers with a specified amount of its products. Breaking such contracts may have serious repercussions for the business. Equally, in regulated industries, the state may effectively impose contracts of supply on businesses. A manufacturer of medical supplies may be mandated to serve state-run hospitals before private clinics, for example. Even in unregulated sectors, politicians may try to create informal contracts, using their influence to secure supplies for local populations or favored constituencies.
In practice, these are not mutually exclusive choices. Supply chain disruption almost always leads to price increases, for example, but businesses can protect their best customers by absorbing some of the cost increase themselves. Contracts may have to be honored but, at least in service-level agreements, only to the minimum standards required.
Unfortunately, some customers will inevitably be disappointed in such circumstances. They’ll end up paying more for what they wanted or receiving less of it – or both. Longstanding relationships may be undermined, with serious implications for the future; likewise, customers who may have become loyal over time could go elsewhere.
To mitigate the danger of alienating some or all of the customer base, companies need a systematic, data-driven process to assess their prioritization options. The rigorous planning that traditionally went into sales and operations will now need to be applied to management of the supply chain.
Building such systems will not be straightforward, however. Demand forecasting models have evolved over many years, but developing equivalent capacity to forecast supply, with its inherent vulnerability to unpredictable exogenous shocks, will be more challenging.
The other imperative in this new reality is that C-suite leaders take a hands-on approach to supply chain management. Tough decisions about how to manage customer needs and frustrations may have implications for the business for many years to come. The business’s leadership should be on-hand to offer advice and finesse relationships with important customers.
Moreover, very often these decisions will create a commercial imbalance in the business structure. Managers may decide to prioritize supply to a market regarded as particularly important, leaving other countries short. Equally, they could allocate raw materials to particularly profitable product lines. Again, these are decisions that only C-suite leaders should take, as they will have the industry experience and oversight of the business allowing them to gauge which way it should lean when it needs to make compromises.
The biggest mistake of all here would be to stick with the status quo. It may be comforting to cling to the idea that supply chain disruption will subside, but it looks increasingly misguided. In a world of escalating geopolitical tension and technological change – and the climate crisis rumbling on menacingly in the background – there will be plenty more shocks to come. Today’s crises may feel all-consuming, but it is never too early to prepare for those of tomorrow.
All organizations must evolve to survive, and sustainable business transformation has fast become the gateway to a new license to operate and compete.
In Issue XI of I by IMD, we explore how to build sustainable organizations to succeed in turbulent times.
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