How Soaring Price
of Oil Is Affecting
Supply-Chain Strategies

Managing Editor
Robert J. Bowman
A conversation with Tim Feemster, senior vice president of global logistics
with Grubb & Ellis Co.

No one is immune from the impact of rising oil prices, least of all global supply chains. More than half the cost of getting products to market is related to transportation and fuel. At a certain point, companies are forced to alter their networks, leading to major changes in sourcing as well as the size and location of key distribution points. The savings that come from manufacturing in regions with cheap labor can be wiped out by the cost of moving goods over long distances. Routing choices in the U.S. can be affected as well. In this conversation with Tim Feemster of Grubb & Ellis Co., conducted at Aberdeen’s Supply Chain Management Summit in Chicago, we discuss the factors that can lead to a “tipping point” in supply-chain strategy, in particular the price of oil.

Q: How important is the rising cost of fuel to supply chains today?

Feemster: The latest CSCMP [Council of Supply Chain Management] study showed that 62 percent of supply chain costs were transportation and fuel. The rising price of fuel is a big driver to that. Everybody in the global supply chain is being impacted. We’re at $3.93 cents a gallon for diesel today. That’s a 21-percent increase over the first quarter of 2009. It’s actually higher than the first quarter of 2008, when we reached our peak fuel price of $4.76 a gallon. It’s starting to have a big impact, both on the transportation industry and on the consumer.

Q: The trend for many companies in recent years has been to consolidate the number of distribution centers and get better efficiencies out of fewer, larger facilities. Is that turning around now, because higher fuel prices have made it necessary? Feemster: Correct. As oil reaches that trigger point, probably somewhere between $125 and $150 a barrel, it’s going to have an impact on network design. People are going to go away from this regionalization that we’ve seen over the last 20 years, back to a more market-centered approach.

You’ll have more distribution centers in the future at $150 a barrel. The overall cost of your supply chain —over 50 percent in transportation, 22 percent in inventory carrying costs, 17 percent in labor and 4 to 5 percent in rent – will be less. That will be true even if you’re paying more for rent, labor and inventory, because your transportation cost will have gone up so much that it [exceeds] the others.

Q: That’s a pretty amazing thought, that transportation costs would become so high as to overwhelm all those other costs.

Feemster: MIT has done some studies on this. They were looking at a consumer products company which had five distribution centers, all the way up to $125 a barrel. As soon as oil went to $150, it went to seven.

Q: Are we going to see more near-sourcing of manufacturing, among companies that had shifted production to China?

Feemster: We very well could. Again, it depends on how high is high, in terms of the fuel cost. On the near-sourcing side, the most obvious option is Mexico. But there are significant problems there from a security perspective, so a lot of companies are shying away from Mexico and going to other South and Central American countries. Or they could come back to the United States. Again, it’s a matter of whether the cost of transport all the way from Asia overcomes the higher cost of labor in the United States.

Q: There are other recent factors that seem to be working against the idea of sourcing in Asia, such as higher labor costs in China and the Japanese earthquake. Does all of this combine to make sourcing in the Western hemisphere more viable in the short term?