Articles

How Finance Deals with Supply Chain Challenges

  • By Bryan Lapidus, FPAC
  • Published: 7/14/2022
Cargo ship with crates on the ocean

Supply chain issues are affecting every single business in the world in some way, shape or form. For an international tire manufacturer and hospital supply chain group, this is a mission-critical issue. So how are they dealing with it? How have things changed over the past two years, and have prices increased as a result? To find out, AFP’s Bryan Lapidus, director of FP&A Practice sat down with Tom Russell, CPA & FPAC, director of Global FP&A for Cooper Tire & Rubber Company, and Pete Geiler, director of supply chain finance for a large hospital system.

Understand your forecasting

Most of the operational planning work is done by the supply chain group at Cooper Tire & Rubber Company. “In finance, we're consumers of that information, but we're also helping shepherd the process and provide information back and forth,” said Russell.

The biggest challenge for Cooper has been how to get the raw materials to their manufacturing plants to produce tires. Natural rubber is a key raw material that is shipped by boat from Asia, enters the Port of Los Angeles, gets loaded on a truck and driven to their various plants; however, the chain is simply more fragile than previous years. In one case, a large load got stuck at port Cooper was within days of shutting down the plant for lack of supplies. “We’ve had to airlift rubber to our plants at substantial costs,” said Russell. Which then falls back to finance to run a cost-benefit analysis to determine whether that is a good decision.

Cooper is also, like the rest of the world, experiencing employment challenges. “People don’t want to work in a manufacturing plant; it's 100 degrees in there,” said Russell. “And the standards that we have set in the past for employees, such as passing drug tests and attendance policies, are rigorous. People can go elsewhere these days and get jobs paying almost as much that aren't so grimy and physically intense.”

An organization has at least two choices to forecast out the impact of variable inputs. One is to estimate what the costs will be or create several scenarios or pathways; the other is to project actuals forward and explain the variance after. “The culture of the organization is not prone to speculation,” said Russell, and forecasting is led by the sales and operations team. They followed the second path. “To my frustration, we’ll take today’s transportation and freight costs and forecast that out for the rest of the year. And recently for every month, we have experienced an unfavorable variance.”

Just-in-time becomes Just-in-case Inventory

On the hospital supply chain side of things, they have added costs and work to get a better handle on inventory management. The problem was both empty shelves in some areas and ballooning inventories in others. “If we couldn't find something, we had to go find another manufacturer or supplier,” he said. “We used to average about 100 backorders on a daily basis. Now we’re at over 1,200 per day.” Sometimes they can't get the product from a distributor, so they’re going directly to the manufacturer who sells in smaller lot sizes, which means their number of purchase orders issued has jumped 30-40% over the last couple of years. The hospital joined a consortiums of other healthcare providers and medical centers, effectively creating a co-operative distribution among themselves. Additionally, in California, a law was passed that said they were required to have 90 days’ worth of personal protective equipment (PPE) onsite, which means more inventory.

The result is increased resources to manage a less efficient process. “We’ve been able to get more money from the executives to get the supply chain boosted up. We're one of the few organizations that actually got an increased budget our hospital,” said Geiler. They have a category management group that functions as product managers, only they’re trying to bring something in rather than sell something. “The category management team got very, very busy,” said Geiler. They have about 20 people for a $7 billion organization, who try to balance cost efficiency with simply getting the needed material.”

The company had to lease a new warehouse just to manage the peaks and valleys of material availability, and to support that, hired 10 new people to manage the warehouse, plus a couple of extra drivers to deliver it to their area hospitals.

On the FP&A team, they had to add more analysis around inventory on hand, particularly the 4,000 items they carry in the hospital. When something comes up as a shortage and they have three days of inventory on hand, it means an impact to healthcare and the hospital’s bottom line. With that in mind, Geiler’s team took a proactive approach; now they take inventory daily in order to calculate weekly and monthly usage to better estimate when they’re going to run out.

Understand potential accounting distortions

Cooper is on a last in, first out inventory (LIFO). As they have sold through their recent layers, they are now selling inventory from much older layers which have lower unit costs. “LIFO accounting has distorted our financial results because our inventory levels are out of whack right now,” said Russell. In other words, with LIFO, Cooper is selling down the historical inventory costs, which have accounting prices much lower than the actual cost of producing a new one today because the cast was put on the books in a past year.

It also means that, once we get past today’s hiccups and Cooper seeks to replenish their inventory, they're going to be saddled with very expensive tires and an inflated balance sheet for the outyears. It won't make a difference on cash flow, but on an income level, it'll look bad and add confusion in conversations with different stakeholders.

Know your most profitable customers

“From the sales and marketing front, we looked at which of our products and customers generated the largest margin and prioritized them in the manufacturing process,” said Russell. Prioritizing sales to the most profitable customers lowered total revenues, but, “our margins increased substantially, and we were actually much more profitable than we thought we were going to be. It was a very strategic move, and one that we have the FP&A skills to pull off. And it paid off,” said Russell. Of course, that means some customers are not able to get the tires they need to sell, but “everybody’s trying to optimize the scenario.” Cooper has also been able to push through several price increases over the past two years to help offset the higher cost of raw materials — and customers didn’t push back because they did not have the leverage to find substitutes.

Be ready to change your reporting metrics and operations

From a healthcare perspective, the hospital supply chain’s CFO is asking more questions about what can be done to alleviate the impact of future events. “She's more focused on the future than she is on the past,” said Geiler. And his reply to her? “We're telling her that we expect the supply disruptions to continue for the next year, that it's not going to get any better until the entire system starts calming down.” They have adjusted their metrics to prioritize fulfillment over efficiency.

In the tire industry, there’s also been more of a focus on day’s inventory outstanding (DIO). “In the past, that wasn't a metric we really focused on,” said Russell. He explained that there was a lot of concern over running out of inventory to sell and looking at each plant across the world, as well as each selling region. “You might have tires that are manufactured in China and sold in the U.S.; we need to know how much inventory is in the warehouses and plants, and whether we’re going to be able to generate revenue,” he said.

“Tire manufacturing is a slow moving, conservative industry; Cooper is over 100 years old. But by our standards of nimbleness, we're nimbler now than we were in the past, and we’re more flexible and creative about how we move our supplies through the supply chain, how we move more materials, and actually make tires. And if that is retained by the organization going forward, that could be useful,” said Russell.

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