This paper is about “sweet spot” industries and other supply chain concepts which buyers need to aware of and paying attention to.
Why has the toilet paper supply been disrupted? There are four main reasons: The first is that the supply chain providing consumer toilet paper is not the same as the one catering to industrial/commercial toilet paper. The second reason is that toilet paper consumption is not usually seasonal when compared i.e. to the drinks industry which experiences peaks in demand in the hotter months. The third reason is that toilet paper manufacturing is what is called a “sweet spot” industry, whereby capital investment is high and profits are made on marginal costs once the core of the capacity is exhausted. The last reason is that toilet paper is a low price, low margin and high volume business, hence ancillary costs such as storage space, handling costs are kept at minimum. The perfect storm or “GAU” as it is called in German. Germans have a word for everything and for once a description in 3 letters “GAU” or many: Groesster Anzunehmender Unfall (Highest Probability Incident).
In this context, toilet paper manufacturers have a disincentive to carry excess inventory and to invest in additional production capacity, in the face of a temporary surge in demand. It is rather their time to finally make more than the usual minimal profit margin by exhausting existing production capacity and supplying Just in Time (JIT) – “hot” off production line. Toilet paper distribution channels also have a low incentive, except from a temporary customer service perspective, to hold excess stock due to the bulkiness and the low margins of the product in case. Transportation companies incidentally also have spare excess capacity, as high weight goods and low value goods are typically best transported through extra light vehicles called Jumbo trailers, with a lower axles which allow for a higher volume above it (in Europe for example, these can carry 38-40 Euro pallets instead of the usual 30-33 so a 25% differential). Moving transportation even temporarily to other means again hurts profit margins significantly as usually 5-10% of the cost of goods (COGS) is allocated to logistics. A perfect storm in a tea cup!
There is therefore no economic justification for anyone along the supply chain to do anything drastic about the shortage. While it is quite exceptional to have a category faced with all these 4 limitations at the same time namely:
– “Sweet spot” and capital intensive manufacturing
– Two entirely different distribution channels
– No seasonality to be anticipated
– Low margin and bulky
any one of these characteristics can occur in a particular category or supply chain and can be apprehended by and offer opportunities to buyers from a supply chain management perspective.
– “Sweet spot” industries offer the opportunity for buyers to buy the core or “economic fixed cost absorption lot” production at cost; that is the cost which covers the return on investment and operating costs of the manufacturers as opposed to purchasing the excess production which is typically sold at a higher profit making price. It is incumbent on buyers to find out which are the “sweet spot” industries, suppliers in their portfolio and where the “sweet spot” is. This is best determined using auctions, in particular English auctions, whereby the suppliers bid lower against a best offer from competitors. Japanese auctions can also be suitable, however, since the decrements are dictated by the buyer, a more precise assessment by the buyer of the “sweet spot” of the suppliers is required to guide the size and frequency of the decrements. The prerequisite in all cases is that the buyer has a reasonable estimate of the economic lot size of the suppliers invited to the sourcing event and has the resources to buy a significant portion of the capacity of any participating supplier. The buyer will become the main and preferred customer of the awarded suppliers as without his business, the supplier cannot sell the excess production to others at a higher profit, having covered his base costs with this buyer. An extreme illustration of this technique with some sophisticated variants, is British Allied Foods, the mother company of Primark, which buys the capacity and capability of a production facility and then dictates what the production is going to be…
– In a supply risk mitigation strategy under this scenario, the same buyer will buy a significant portion of the “sweet spot” production from another supplier, to ensure that again his company becomes a preferred albeit not main customer of said supplier. This will help the customer overcome unexpected increases in demands as his contract is a long term contract as opposed to a one-time purchase.
– Quid if the goods are bulky, heavy, low margin or again have any other attributes which makes them quite specific from a supply chain perspective?
Let’s go through a few practical examples:
Potatoes are heavy, low margin, low value but in some countries are critical and usually transported in bulk, by barges on the longer haul to their points of distribution. The advantage of such a good is that storage requirements are also low (a shed) and shelf-life is long. This means that extra storage is a good option as a mitigation strategy.
An essential such as fuel, (and we had a shortage in the 70’s), is heavy, requires specific transportation means and distribution channels, is high margin for the producers but low margin as far as the distributors are concerned, it requires dedicated and sophisticated storage facilities but it has a long shelf-life. It also happens to be in a sector (except for producers which are voluntarily refraining production such as Saudi Arabia), which requires high financial investment with a significant delay in output. A buyer buying fuel, should not only hedge the currency (if not in a country with US dollar denomination), but should also make use of extra storage capacity as well as move some purchases to Bill of Loading (B/L) purchases, that is goods in transit to provide for some flexibility. Doing the latter obviously requires expertise in trading.
The cotton market perfectly illustrates how this works: Traders buy a production more or less blind as they do not know the final quality qualification of the cotton yet, once it is available organize it’s certification, ship it before it is certified to be of a certain quality, then sell the load at sea based on the certificate results received in the meantime. This allows to 1) secure the load 2) accelerate the shipment (long lead-times) 3) sell it at the right price before for example duties and customs are incurred 4) cash in upon the ship docking through the means of a Letter of Credit (L/C). A buyer using this purchasing mode on a consistent basis would always have a spare potential supply pipeline in place in addition to the regular more static one. For this, Dutch auctions whereby the price increases from a low base is recommended as the objective is not to buy at rock bottom price but to secure the supply at a reasonable market price.
A few hints: for bulky but light weight, chartering an aircraft and filling it in bulk is a good option if the goods are worth it. If they are heavy, consider barge transportation or train transportation as a substitute for road transportation, bulk loading instead of pallets or crates is best, container and train wagons are cheap to rent, and can be used at temporary storage.
In addition, to these sensible alternatives, one does have to plan for staff to load by hand, staff to repalletize, intermediate transport means to bring and pick-up from port or train station, staff to refill manually, handling staff etc… This should be part of a business continuity and contingency plan.