Logistics Management Group News Editor Jeff Berman recently spoke with Michael Farlekas, CEO of Austin, Texas-based connected supply chain software platform services provider e2open. Farlekas provided Berman with an overview of various topics, including: a return to supply chain normalcy; inventory management, and sourcing options for shippers, among others. Their conversation follows below.
QLM: How do you view how retailers and manufacturers have been exercising cautious inventory management practices given the continued drop in global shipment volumes, which are well below levels seen at this time a year ago?
AMichael Farlekas: There will be lots of books written about the disruptions that happened because of the pandemic. My view is that the biggest disruption was consumer behavior. You never had before—in our lifetime—everyone in the world changing their behaviors dramatically at one time. That was just kind of a function of the world saying let's just not travel and stay home and focus on not getting everybody sick. The system of getting and making goods into the market is a continuous system. It never really shuts off, but it's always built around marginal changes, where you have a company that's always looking to see what the demand and supply balance is. So, if you're a manufacturer or a retailer, all you're really trying to do is manage, supply and demand right. For example, I think I am going to sell 10 units. How do I make sure I have around 10 units there, so I don't have stockouts, and I don't have too much inventory?
The changes that companies make in that process have really have been really actually very small, as it relates to that, because they just make it come out…and that doesn't show up anywhere. And because of the massive change in consumer behavior that nobody could predict, it just changed everything. It just went from super-high demand to no demand to now kind of reverberating and kind of getting back into a normal cadence. My view—and I've been saying this now, for the past six-to-nine months—is it is going to take a little bit more time to let those ripples kind of settle out, and I think those ripples are selling out and I think they're getting smaller in their changes. The circles of change are getting smaller, and more incremental. And I think what that means is it's just getting back to a more normalized run rate of understanding supply and demand more effectively. And then just getting back to making the small adjustments. I think we're kind of not quite through that, and it's a bit of a function of industry where you still see some industries dealing with this issue more than others. The more they're on the capital good side, for consumers especially, then the more they're still going have this issue. The more it's on consumables, the less they're going to have that issue. And I think that's kind of how we see things with our customer base, I would expect you know we're still probably in this for a little while longer, but it's becoming, or will quickly become, a thing of the past where you're not really thinking about it anymore. I think we're probably still a quarter or two away from there, where the overall macro environment will then be the primary topic of the conversation rather than supply chain change because of Covid.
QLM: A lot of recently-issued port datasets are showing declining import volumes, for a few different reasons, but, at the same time, inventories are, or have been, elevated, to such a degree, and now they are being worked down. That has led many industry stakeholders point to the back half of 2023 being the start of a more normal flow, or cadence. Do you see it that way, or is it more of industry vertical-specific?
AFarlekas: Things are on the way to normalization, and on that pathway, you are going to have it being more normalized for some industry sectors and still less normalized for others. The easiest way to look at it is in a transportation cycle, because it all shows up there. The biggest change in the last nine months has been the inversion of a contract in transportation rates versus spot rates, so that's inverted, and there's a lot of excess capacity in the U.S. trucking market today. That becomes a big deal, because it also affects your global trade, to the extent you have in which you know where things are coming from and going to affects which ports are going to be used. So, do I bring things over through the West Coast, or do I bring them through the East Coast? That then translates into supply and demand for the freight itself. The carriers are always going to try to maximize price where demand is high, and increase the amount of revenue they get when demand is slow for a particular area. They're always kind of balancing that out. And the inland global transportation costs play a big deal. Those people vote with their feet every single day and decide how they are going to route something, and I think that's still kind of in the in the workout phase.
I really think it's kind of back half of this year where you get back to like “OK, this is enough. It's behind us, because there really aren’t too many more disruptions that we're seeing.” That is what we're seeing in the data and what I sense from our customers. There's just such a massive amount of a purchasing for goods that look like they last for three-to-five years. That's the thing about a computer. When you buy one that lasts for three years, you don't really need another one for three years, so I hope I hope not right, so you just pull that demand forward.
QLM: Coming off of this unprecedented period of time, coupled with the sentiment that things will be better, or more normal, over the second half of the year, how do thing that will impact spot and contract pricing, which have seen a fair number of shifts over the past several months?
AFarlekas: As a short-term trend, there were a massive amount of rate increases happen all at once. In the trucking industry, it is fairly easy to get into the business. If you see rates going up, you can quickly kind of add capacity by just going out and buying trucks that fuel the increase in the economy. So, you have this increase the capacity based on something that you would argue was artificially high [as was the case during the pandemic]. Then that inverts and now you're on the other side of that, and you know you're going to have wash outs. People are going to go out of business. That's going to lead to excess capacity. I think that does normalize; that's a short- term issue. I think the longer-term issue, though, is a little bit more profound, which is that the rise of the digital freight broker is changing things a lot, in our view, and we're participating in this. The price, discovery and transparency for transportation is going to go way up in its use, meaning you're going to have less of a difference between what's called a contract price and a spot price. Why do I want to contract? I want to contract if I'm a shipper, because I want guaranteed capacity. So, what they found, though, is that even though they had a contract with a trucking company, the trucking company didn't always fulfill that. They said they have a truck so I went to spot. So then, all of a sudden, I got a couple of brokers and they are the ones providing my spot [loads]. If the contracts is not really valid for the shipper when they need the truck, they're not going to be as loyal when the time comes the other way. But the other is a more practical issue, which is because you can now create automatic pricing. Digitally, that means you get instantaneous price quotes that are market ready.
And there's a lot of technology and data being used. And we're doing that and actually participate in this, because we allow brokers to introduce a price at the point, so it's making a decision like a real-time quote like, right now, based on that lane specifically. That is informed by a lot of data and a lot of AI. Long-term, my view is that you're going to have much more transparent pricing and much more price discovery available instantaneously and not allow companies to access the spot rates more wholly and when times are tight be able to get at capacity they need. And when times are slack, they can get that pricing they need. I think it becomes less of contract versus spot, and more just the industry morphs to a much more transparent, pricing mechanism. You have price transparency today within the airline industry, like anybody can go up today and ask, “what's your price?” and you can make a real-time decision.
It's hard to do that in a shocking environment, because you don't have four carriers. You have, tens of thousands of carriers, and the brokers become the permutation of those carriers. As digital technology comes into play, there's going to be easier and more effective ways to get price. And I believe it's going to become much more of a marketplace. That's why I see as a long-term trend. It's not just APIs. It's also a process change. Right now, if you want to ship something, you have to have a contract. I can envision a day when you have standard contracts. right like you know of. As an example, when my kids went to college, there was a common application, and schools quickly figured out that it's better for everybody if everybody agrees on a common application, and that's what you use. I would think that companies are going to start to get into standardized contracts. I think that changes the process, and that means you can have more access to more pricing. For shippers, on one hand that means that they like their carriers and want to have a relationship with them. On the other hand, the CFO is going to say that is great but needs the best price the company can get.
QLM: Looking at labor, how do you think companies can combat labor costs
due to inflation and what types of challenges does that present?
AFarlekas: If you look at the numbers for some areas where you have disinflation and some numbers where you have strong pricing that is still continuing, the more the category is for consumable products, the stickier the pricing is going to be. For things more discretionary in nature, the faster it is going to show up in price because it affects inventories. When inventories get too high, price needs to be lowered because it costs a lot to sit on it and store it, especially for something that is timely in the marketplace. If I have shovels in mid-March, either I sell it or pay to store it somewhere until next year or get it to a different part of the country. I think you will start seeing the cracks of inflation and are starting to see that, for things that are less consumable goods. And consumable goods will stay on as long as possible. That will be the stickiest and hardest thing to change, because the consumer companies have power and they're never going to want to give up price. This affects margin so greatly, and the only reason and way, they'll actually lower their price—and they're not going to do it through core price—they'll do it through promotion first rather than you know actual price. Companies want to hold on to price for as long as possible, and any reduction in input costs will not directly translate to the price at the checkout counter. But they're not related items. So, a company will very quickly say to get your cost as low as possible, and your price as high as possible, and I am going to manage those two things independently based on different sets of implication. That's why it's sticky. If I am a soup company, and my transportation costs go down by 10%, they are not looking to pass that on to the consumer. That, in turn, helps to offset higher labor costs. Labor costs have two dynamics. One is that core inflation hits labor directly. But, also, I think you have a bigger issue of supply and demand and labor. That is probably the bigger driver of labor costs than just a core inflation. I think companies aren't paying people more and labor cannot barter for more, not because their costs are higher.
But it's simply a function of there's a supply and demand mismatch, in terms of labor markets. That is due to immigration lacking during the pandemic to help fill jobs and also people being under stress and saying they are not going to work anymore or change their work habits. That shows up, too. I think that's a more of a persistent item, as it relates to labor with labor costs, and I do think labor costs are going to be here for a little while. I think it's more about supply, demand and balance than anything.
QLM: The rate environment has seen a lot of fluctuation across various modes, with many now at pre-pandemic levels. Where do you see things going, given all the moving parts out there, at the moment?
AFarlekas: Over time, transportation costs seek their own level. It is like water, in that it will get to the right level. Transportation is a massive cost for most of our customers. There are going to be a lot of people inside of organizations doing lots of modeling and lots of figuring out what the right way to go about their transportation spend is. If a company can save 5%, that is a lot of money. That is a constant pressure on how things are moved and why they are moved, but economics literally becomes the most important factor.
QLM: How do you view the possibility of companies starting to think more about domestic production and sourcing to be better equipped for the unexpected and also to save costs?
AFarlekas: Companies will always evaluate what they think are long-term input costs, and they'll always optimize for where their ingredients or product or inputs are coming from and where they're going to. That's always a function of how these markets evolve over time. The input costs are labor, transportation and materials. That's basically it. Once you build a plant, the plant is built. But even if I build a plant, if my economics change dramatically, I will probably be happy to abandon that plant or repurpose the plant and move somewhere else. The timing of that is measured in a multiple-year timeframe. If I can make a decision for five years, and it makes sense, then I will make it, and then worry about it later. If I have to move it again, then I will move it again. Markets evolve, and infrastructure evolves. The beauty of our system is that capital and dollars will flow to where demand is. So, a company, for example, will move its product to where its primary markets are located.
QLM: Does that also apply to
AFarlekas: Yes. It is less expensive to move bulk material than it is to move finished goods. If I am moving plastic pellets, it is cheaper to move a lot of plastic pellets to a market than it is to move the finished product itself on a volume basis. That is the other piece of it, looking at total landed costs for everything and a company will make a decision based on what they think the landed costs are. As offshore labor increases, the difference in transportation costs becomes more profound. If I make something in Asia and I have to ship it to New York, I have to pay to handle it and ship it, deal with inventory and the breakage and other things. But if is closer, I can move it by truck, and, for the last 25 years, the cost difference in labor has been pretty important. To the extent I can use less labor because I can automate more, that changes the equation…where I need five workers, I can use two workers and the advantage of low-wage labor becomes less. I think it's a function of industry. I also think it's a function of the overall global economy. I'm not a big believer in a wholesale re-trade of moving lots of industry back to the U.S. I think you'll have more finished good manufacturing, but you'll continue to see components resource from everywhere. I think overall it'll be based on what competitive advantage a certain reach has over another and then continuing to exploit that competitive advantage. And then the assembly happens where the assembly happens. Companies are clearly de-indexing off of China. But that does not mean they are going to reshore all of their manufacturing. It is not that simplistic.
QLM: As we have gotten through the pandemic, do you think we are at a point where we are seeing, or even feeling, sone signs of a return to supply chain normalcy, of sorts?
AFarlekas: I think it is getting back to normal. The bullwhip effect was in full force and we are now on the other side of that, with a big change stretching out into smaller changes. I think it is getting way more normalized. That does not mean it is not painful for certain industries, and it does not mean there will not be disruptions here and there. Life is returning to a new set of normal. Will it be the same set we had before Covid? Probably not. But the system is going to adjust to whatever the new set of normal are. At the same time, it allows you to be a little bit more circumspect about these changes. You have to be prepared to deal with anything at any time and move forward the best you can and not get too wound up about any change, because there is probably going to be a different one tomorrow.