What caused this breakdown?

Wednesday, 29 June 2022 — Albert Park

[3 min read]

Dear Reader,

So we have a supply chain breakdown. But what caused it?

Jim Rickards says that ‘two Es’ are to blame — efficiency and energy. While we think of these as positive goals, sometimes they can have unintended consequences…

Keep reading below to find out more about the first E (efficiency) and some of the techniques commonly used to achieve this in supply chain management.

Regards,

Callum Newman,
Editor, The Daily Reckoning Australia

Dear Reader,

The breakdown in the global supply chain can be summarised in two words: efficiency and energy.

Efficiency sounds like a desirable outcome. It implies cost reductions and lower prices for consumers. How can efficiency be undesirable?

All systems require some form of energy, yet energy appears to be plentiful on a global basis, notwithstanding higher energy prices. How can energy be blamed for the breakdown?

These questions present the paradox of complex dynamic systems analysis. The global supply chain is one of the most complex systems ever created. Here’s the explanation of the paradox…

We’ll begin with efficiency.

Supply chains have been part of commerce for as long as there has been commerce. A Late Bronze Age vessel discovered in 1982 by a local sponge diver at Uluburun, off the coast of Turkey, was found to contain cedar from present-day Lebanon, ebony from Africa, oil lamps from Cyprus, amber from the Baltic Sea area, a cartouche from Egypt, and many other tools, weapons, and jars from various points in the Eastern Mediterranean. That vessel was clearly at the centre of an extended supply chain.

Adam Smith wrote extensively about supply chains in his 1776 book The Wealth of Nations. He did this to illustrate the economic role of productivity, the division of labour, and free markets.

Still, the modern science of supply chain management didn’t begin until the 1980s. That’s when the rise of globalisation and the expansion of computing power combined to make supply chains more complex, while offering tools to deal with the complexity.

Supply chains can be thought of as a bundle of costs that manufacturers bear in order to realise revenues (and hopefully profits once the costs are netted against the revenues). These costs include sourcing inputs, transportation, manufacturing processes, labour, equipment, distribution, inventory, and associated legal, administrative, and insurance expenses.

There are limits on what producers can charge for their products based on consumer preferences and competition. Given those limits, one of the most direct ways to increase profits is to reduce costs. Supply chain management takes aim at those costs by creating options, sharing information, eliminating redundancies, encouraging cooperation among supply chain participants, and other innovations.

Techniques to optimise efficiency

These efficiency techniques are numerous and go by many names. Here's a summary of some of the most widely used techniques…

Lean: This is a technique developed by Toyota in the early 1980s and now almost universally adopted. It is sometimes referred to as the Toyota Production System (TPS). The idea is to run a supply chain with the least amount of time, effort, and money necessary. Specific innovations that have emerged from lean techniques are just-in-time inventory and the idea of minimising shipping costs by co-locating related functions. Lean aims to reduce motion, wait time, and inventory at every step of the production process. It also seeks to eliminate overprocessing (steps that don’t add value) and defects (in part by tapping into the skills and creativity of rank-and-file employees).

Six Sigma: This is a statistical methodology designed to minimise variation in production processes. The idea is to have a smooth process that reduces product defects to the sixth sigma (6σ). Statistically, this translates into 3.4 defects out of 1 million events. Six Sigma is implemented through a five-step process described as: define, measure, analyse, improve, and control. Since this is a process of continuous improvement, it’s sometimes combined with lean into a program called Lean Six Sigma.

Theory of Constraints: This methodology begins with the assumption that every supply chain process is constrained by a single step, which is the slowest in the chain. If an assembly line requires 1,000 tyres per day to produce vehicles at maximum capacity, and the warehouse can only supply 800 tyres per day, then the assembly line must slow down to a point 20% below capacity because of the delivery constraint. Once these bottlenecks are identified, available resources should be used to fix the bottleneck in order to make the entire supply chain run more smoothly and increase output to capacity.

RACI matrix: This is a supply chain management technique used to improve teamwork in solving problems. RACI stands for responsible, accountable, consult, and inform. It’s intended to let every member of a team know what they are responsible for doing, establish benchmarks to hold team members accountable for performing their tasks, encourage consultation among team members to ensure that efforts are coordinated, and inform team members if specific tasks have been accomplished or are ongoing.

DIRECT model: This is a technique used by leaders in supply chain management improvement projects. It’s another acronym that requires managers to: define the objective, investigate the options, resolve on a course of action, execute a plan, change the system, and transition people to new roles once a project is completed.

SCOR model: This is another management tool for those involved in supply chain optimisation. SCOR stands for Supply Chain Operations Reference. It’s a framework for mapping supply chain improvement processes and evaluating results. The high-level elements of an efficient supply chain are defined as: plan, source, make, deliver, return, and enable.

As you can see, there are many different techniques and tools for improving efficiency in supply chains. But what are their hidden costs? Make sure you read my next edition of The Daily Reckoning Australia to find out.

All the best,

Jim Rickards,
Strategist, The Daily Reckoning Australia

This content was originally published by Jim Rickards’ Strategic Intelligence Australia, a financial advisory newsletter designed to help you protect your wealth and potentially profit from unseen world events. Learn more here.

Dear Reader,

Bloomberg has the latest: ‘Metals Haven’t Crashed This Hard Since the Great Recession’:

‘Industrial metals are on track for the worst quarter since the 2008 financial crisis as prices are pummeled by recession worries. Copper, the great economic bellwether, has ricocheted into a bear market from a record four months ago, while tin just tumbled 21% in its worst week since a 1980s crisis froze London trading for four years.’

Mr Market is doing what he always does. When things are too expensive, he marks them down. When they are too cheap, he bids them up. If there’s a shortage, he increases prices to bring forth more production. If there is a surplus, prices crash, and producers cut back.

Mr Market always does the right thing at the right time. If there is a boom, he throws on cold water. If there is a bust, he brings a bottle of Jameson and a loaded pistol.

He deflates bubbles…but breathes air into flattened industries.

Blowing bubbles

The crypto bubble, for example, has now lost US$2 trillion of gassy value. Cryptophiles are hoping they’ve seen the end of the deflation. Bitcoin [BTC] is holding above US$20,000 — for now. They’re waiting for some oxygen. But are cryptos part of an industry worth saving…or just a faddish speculation? We’ll wait and see.

After hitting record highs, shipping rates are coming down, too. People aren’t buying as much stuff; so there’s less need to restock the shelves. And the price of oil is also falling.

Higher mortgage rates have hit the housing industry. Sales of existing houses are down. And there’s less hammering going on in the construction business. Markets Insider has the story:

‘Lumber prices fell Thursday, marking the first decline in more than a week, as mortgage rates rose to the highest level since November 2008.

‘Prices ticked down 2.3% to $598.50 per thousand board feet, after rallying for six consecutive sessions to edge back above $600. Earlier this month lumber tanked toward a nine-month low as gloomy housing indicators continued to pile up.’

Yes, Mr Market is at work…settling up…putting out-of-whack things back into whack.

But count on the dunderheads in Congress to misunderstand everything.

Elizabeth Warren came forward on Wednesday. Addressing herself to Jerome Powell. HuffPost reports:

‘Sen. Elizabeth Warren (D-Mass.) told Federal Reserve chair Jerome Powell that he should be careful not to “tip the economy into a recession” with interest rate hikes.

‘Warren told Powell, “Inflation is like an illness, and the medicine needs to be tailored to the specific problem, otherwise you could make things a lot worse.”

‘Warren asked what was worse than high inflation and low unemployment and then gave Powell an answer: High inflation with a recession and millions without jobs.

‘“I hope you consider that before you drive this economy off a cliff,” she said.’

Another dopey moron

Poor Mr Powell cringed. In front of him was a moron…lecturing him about inflation.

Didn’t she know? Mr Market is in charge now. It is he who is driving towards the cliff. But a cliff is not the end of the world; it’s just a correction. Yes, of course, he could see it coming. What did she think he was, an idiot?

And what was this ‘inflation is an illness’ claptrap? Does she think there is some pill the Fed can prescribe…and then after a few days of bedrest, the economy will be good as new?

What a dope!

Mr Powell knows that he only has two choices. He can let Mr Market go about his business — correcting the Fed’s error…straightening out the markets…and bringing things back to some semblance of ‘normal’.

But in that case, he will have to stand up to know-it-alls like Ms Warren. Will he have the guts to do it? It won’t be easy. As the economy sinks, she’ll turn up the volume, looking for even bigger headlines. She’ll claim that he, Jerome Powell, pushed the economy over a cliff.

And then, what will he do?

That’s his second choice: he can intervene, stop the correction, and go back to printing money. The result will be a total disaster…not just for the economy, but for the nation and everybody in it — hyperinflation, war, revolution, hunger, cold, poverty…the whole shebang. But it will take years to develop. And in the meantime, he’ll get Madame Warren off his back…and be treated like a hero. He’ll prove that he, too, (following in the footsteps of that insufferable twerp, Ben Bernanke) has the ‘courage to act’.

These thoughts must have raced through the Fed chairman’s mind…along with the ‘b-word’…as he faced his antagonist on the Senate Finance committee.

But it’s way too soon for option #2. So, what could he say?

The way forward, he told the Senate committee, will be ‘very challenging’.

Regards,

Bill Bonner,
For The Daily Reckoning Australia