Prices of indirect-MRO supplies are expected to rise an average of three to six percent in 2006. The good news is that strategies already in place can more than offset them.

The editor of MRO Today asked me for some comments concerning the impact of current and recent events on inflation for 2006. Certainly, 2005 has been a record year in terms of major events — a record number of hurricanes including one Category 5 storm that hit the offshore facilities in the Gulf and the major refinery centers in Texas and Louisiana.

Moreover, the hurricane season is not yet complete. The storms along with many other unsettling and inflationary events have combined to foster price increases in the range of three to six percent for many commodities and industrial suppliers. Price increases for petroleum-based products may be even higher.

Rest assured that many, if not all, of your suppliers in most of the indirect-MRO commodities or services will be demanding price increases and some of these demands for immediate increases will be in the form of requesting changes to existing contracts granting immediate relief. The ISM Report on Business (ROB) shows that prices for many commodities are going up.

It is always true that some commodities and industries are price leaders. For example, we all know about the run-up in gasoline prices and the related costs of other fuels. We know that all petroleum-based products will be under extreme inflationary pressure in the future and I expect well beyond 2006.

The level of petroleum-based content in a product will be an indicator of the efforts to increase its price. Similarly, fuel costs will impact nearly all transportation costs, from air travel to motor freight along with my SUV.

Many of my contacts in supply management that buy lots of minerals tell me that they are under huge pressure to pay more for carbide-, tungsten- and nickel-based products. I expect that most other metals will follow these models.

Industrial News Today reported pending worldwide shortages of cement to support the growth of the worldwide construction industry. Here again huge increases in demand from China and other rapidly growing economies, combined with anticipated rebuilding of areas destroyed by the storms in the South, outstrip the anticipated capacity of existing production facilities.

As a supply manager you face some very interesting problems over the next several years and beyond. We can see the problem with price increases, but you will also have unexpected problems caused by supplier performance. Some suppliers will not be able to handle the inflationary problems and will become troubled suppliers or worse; they may disappear from your supply chain. 

But don’t throw up our hands and shout despair. All is not lost!  Now is the time to fight like the devil to train your supply managers and help your suppliers!  Make the ROB and other price reports along with the appropriate PPIs available to your people and urge them to use the reports.

We have several tried and proven supply management strategies to help us work through these tough times and be a better supply chain on the other side. First of all, I think we must expedite the training and development of our people to ensure that we are using the best possible supply management strategies and processes.

For example, much of indirect-MRO can be classified into commodities and put under expert commodity managers. I know organizations and companies that still do not use a P-Card or other automated techniques to reduce transaction costs. A 15 to 25 percent reduction in transaction costs will help smooth over many other inflationary problems. Think big!

Our first impulse is to resist all price increases and even more so if we have an existing long-term contract without escalation clauses. Much of our ability to resist is decided by the size and power of the supplier. Your risk here is that you may cause smaller suppliers to default and lose them all together.

Strategy tells us to work with suppliers to reduce all other operating costs involved with the contract. Map your supply systems and lean out other costs to help support supplier margins. You know that your organization is also trying to move cost increases up the line to customers and we need to work to ensure that the total cost of incoming materials is included. Any new escalation clause should be accompanied by a corresponding and equal de-escalation clause.

Strategy also tells us to take a new and in-depth look at our own operations to reduce demand, eliminate more waste, eliminate duplicate inventories and consolidate other inventories and reduce the levels of product in the pipeline.

All of these inventory techniques help reduce demand for scarce commodities and tend to lower total demand. Hence they work to reduce price pressures. It works!

Longer-term strategies tell us to move from the old technique of purchased price variances to control and measurement based on the total cost of ownership. This process reinforces our efforts with suppliers and inventories.

Evaluate and change the buying processes. In many cases common commodities can be placed in auction and reap significant cost reductions even in the face of inflation. Similarly, you may need to look for newer more efficient suppliers and even product content change.

Certainly, we face tough times ahead and much will happen, but those of us that exercise the proper supply management strategies will make it through the turmoil and be better for it all on the other side.

Resources:
For more information on MRO supply cost predictions and usage estimates by industry sector, visit these Web sites:
• The Institute for Supply Management’s (ISM) Reports on Business page online at http://www.ism.ws/ISMReport/index.cfm.
• The Bureau of Labor Statistics’ Producer Price Index at http://www.bls.gov/news.release/ppi.nr0.htm. 

This article appeared in the December 2005/January 2006 issue of MRO Today magazine.  Copyright 2005.