Spend Management: Preparing for an Economic Slowdown (Part 1)

Even though I've been talking about the potential for an economic slowdown on these pages for some time, it looks like some of my rants are being confirmed by more qualified sources. According to the above-linked article in the Supply and Demand Chain Executive, a new report from the Manufacturers Alliance is citing that "a confluence of challenges including the recent housing collapse and credit crunch, rising oil prices, slowing employment growth and lack of consumer confidence" are signaling "a significant near-term economic slowdown." But this time around, a few things will be different. For one, the weak dollar will keep exports -- and some types of manufacturing activity -- higher than one would ever expect during an economic contraction or recession. And it will also slow the growth of imports and global sourcing activity. According to the study, "Export growth should outpace that of imports by a wide margin by the end of 2008. Inflation-adjusted exports should rise 7.7 percent in 2007 and 8.7 percent in 2008."

Given this rather odd mix of lower overall economic activity combined with a booming export market, how can procurement and operations organizations expect their roles to evolve in the coming year? I think there are probably five distinct changes that we'll see. These are:

1) Reinvigorated efforts around sourcing (and re-sourcing)
2) Greater consideration of moving from fixed to variable cost structures (which will also, in theory, help companies scale up and down procurement efforts more quickly)
3) A newfound mandate to focus on overall supply chain risk
4) Ongoing and increased efforts to cut services procurement and non-production related expenditures
5) A greater embrace of the words in Lord Byron's famous quip: "Cash is virtue"

Today, let's explore the first area. As I write this post, backwardation is occurring in the copper markets. What is backwardation, you ask? According to Wikipedia, "it means a downward sloping forward curve (as in an inverted yield curve): one says that the forward curve is 'in backwardation' (or sometimes: 'backwardated') ... Formally, it is the situation where, and the amount by which, the price of a commodity for future delivery is lower than the spot price, or a far future delivery price lower than a nearer future delivery." The reason this matters for our purposes is that current demand is more robust than forecast demand -- which is a signal that contract prices will fall.

In declining price markets, it's not only a great time to re-source -- or invoke de-escalation clauses -- because commodity prices are falling. It's also a good time to source because there's a chance that a new set of suppliers will be more interesting in filling capacity just to stay busy and will accept a margin hit on new business. This also holds true in services and indirect categories as well, considering that rising inventories and newly available capacity will create greater competition in competitive sourcing environments where previously, constrained capacity might have led to reduced savings opportunities. So as we gear up for a downturn, get your sourcing pipeline ready for 2008. And don't be afraid to revisit categories that you recently sourced. There might be savings in them there recessionary hills!

Stay tuned for the rest of this series in the coming days and weeks on Spend Matters.

- Jason Busch