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Businesses across the globe have been operating with a foot in two seemingly opposed realities.
Companies have enjoyed booming demand over the past year, spurred by a broad recovery from the COVID-19 pandemic. At the same time, continued market turbulence caused by supply chain disruptions, persistent inflation, regional lockdowns, the Russia-Ukraine conflict, and chip shortages have prevented many companies from capturing the full benefit of breakneck growth. The rising interest rate environment has added further uncertainty in goods and services prices across the value chain.
The chemicals industry offers a potent case study for analyzing the potential impact of this dichotomy on even its biggest players. Based on commodity-level analysis, AlixPartners forecasts the industry could face $250 billion of raw material cost inflation in 2022. How can companies realize margin expansion when costs escalate across the wide spectrum of raw materials that are foundational to the products they sell? Furthermore, as inflationary pressures ease, how can companies take preemptive action to capture value from suppliers?
At AlixPartners, we developed the supply chain digital twin to effectively answer these questions for a company positioned at a critical intersection of the industry’s value chain. This unique model has proven capable of delivering immediate results and can be replicated at various sized operators in specialty chemical, agriculture, and petrochemical markets. The analytical approach provided commodity-to-end-product cost visibility across the company’s entire value chain. The rapid results are enabled by concrete action steps, including standing up an “inflation control tower.”
In one of our leading supply chain digital twin case studies, a major chemical company used our process to engage in dynamic margin management. By harvesting unique real-time insights, our client conducted data-driven supplier negotiations that resulted in:
- Deflecting nearly 50% of cost headwinds received from suppliers
- Improving business-wide raw material cost forecast by 5% between reductions and deflected headwinds
- Greater than 300 basis points (BPS) margin expansion
- Establishing forward-looking view of deflationary opportunities up to 3 years into the future
Below is a brief look at the challenge we addressed, the capability we built, and the way it was deployed to generate value:
Rising costs, limited visibility
Businesses are often built to attack problems in functional disciplines, at times leaving little opportunity to fully address multi-disciplinary problems. This can leave management teams without an end-to-end value chain view of the products or services they offer.
For the chemicals industry, this can often lead to insufficient visibility into underlying feedstocks and an inability to make effective procurement and commercial pricing decisions at the final formulation level. Because of the high volatility in raw material cost, timing impacts, complex bills of material (BOMs), and supply chains that span multiple synthesis tiers and global geographies, limited visibility impedes the business from achieving its full potential.
When key leaders ask their teams what is going to happen next, they are often greeted with shrugged shoulders instead of reliable forecasts. The leadership challenges that exist to create true outcome visibility are real – organizational ownership, complex processes, matrixed or functional organization structures, disconnected information sources, bifurcated focus on cost and pricing versus margin, and others. These all make effective planning nearly impossible.
Commodities that are critical to the chemical industry have undergone significant and broad-based inflation since the outbreak of the COVID-19 pandemic, with force majeures in the United States, China (recent lockdowns), and Europe (Russia’s Ukraine invasion) exacerbating the problem. For example, a basket of six commonly used commodity feedstocks had reflected a 316% increase in North America since 2020.
Solution required
The client’s goal was to deliver margin improvement amid high and uncertain inflationary conditions, while positioning the company to quickly pivot when the situation eased. As commodity markets fluctuated, suppliers routinely raised prices leaving producers with limited options. They could keep passing them on to an end customer who is also under pressure; push back against supplier partners without knowing all the facts; or watch profitability erode at an alarming pace.
Protecting margins amid disruption doesn’t happen without a plan. In this application, AlixPartners’ supply chain digital twin was designed to address the problem by facilitating these steps:
- Leverage existing company data to connect commercial product demand all the way to underlying commodity feedstocks
- Deploy a sustainable, scalable, digital twin solution to provide visibility across the value chain and anticipate margin challenges
- Identify direct materials margin improvement opportunities to mitigate cost pressures through an inflation control tower
These steps are foundational to improving margins during both inflationary and deflation periods through the dynamic margin management strategy, outlined above.
How the digital twin works
AlixPartners’ supply chain digital twin is designed to work alongside the actual business to provide more concrete analysis, potential outcomes, legitimate offsets, and practical scenarios. It works from inside the company to create end-to-end visibility across the value chain that spans the furthest reaches of upstream suppliers all the way to the end customer. No part of that chain – from logistics to conversion, drayage, and duties – is ignored or left to guesswork.
The digital twin captures market-level headwinds through an unconstrained view, while leveraging procurement expertise to create a buyer forecast, that replicates how the company expects these headwinds will manifest. This is timed to the company income statement.
The supply chain digital twin model enables the following three workstreams to put insights into action and drive direct material cost improvement.
Procurement management tools establish a “should cost” model utilizing calculations based on market and commodity indices. The supply chain digital twin provides projections to help buyers update raw material-level forecasts on costs and timing. This leads to sustainable end-to-end margin visibility for financial planning.
The inflation control tower (ICT) leverages these tools to generate cost headwind and tailwind insights to actively support negotiations to deflect, defer, and reduce supplier costs.
The ICT provides tactical support to procurement professionals to identify cost actions –can you effectively delay, minimize, and/or recover cost increases on materials amid inflationary headwinds? The ICT also provides insights to help proactively engage on supplier pricing negotiations ahead of market tailwinds to effectively capture deflationary dividends.
Finally, commercial management tools from the supply chain digital twin can be leveraged to optimize pricing decisions. This includes updating final formulation prices to capture pricing opportunities when warranted by the market movements or customer specific pricing. A result of commercial effectiveness is being able to identify and execute price increase opportunities at the individual SKU level as soon as inflationary headwinds are realized.
Summary
The turbulent market presents many opportunities for margin expansion. While inflationary pressures have dominated markets since 2020, deflationary trends in many raw material sectors present increasingly enticing margin enhancement opportunities. In AlixPartners’ recent experience, generating dynamic margin management visibility shouldn’t take months or years. In fact, gaining end-to-end visibility can typically be created from existing systems in less than ten weeks when a client and AlixPartners team up.
Companies that are best equipped to forecast demand accurately, procure raw materials effectively, and price products competitively amid market volatility will emerge as the market leaders when the dust settles. The AlixPartners supply chain digital twin serves as a practical enabler for companies to rapidly build this cost-to-price capability and take action to generate financial results.
