Although inflation has eased in the largest economies, many companies are still struggling with operating their supply chains in countries with extremely high inflation, says supply chain management consultancy INVERTO, part of Boston Consulting Group.
INVERTO’s says that 6% of countries globally (12 out of 190) currently have extremely high inflation levels of 25% per annum*. This includes economies that play a significant role in supply chains of UK and European companies like Turkey and Egypt.
INVERTO says that having part of a supply chain in a high inflation economy is a significant challenge – partly because suppliers may face bankruptcy, undermining supply chain security. The instability created by higher inflation could also see a key supplier get into financial difficulty and leave a damaging hole in the customer’s supply chain.
Where higher inflation is accompanied by a depreciating currency then there may come a point where the supplier can no longer afford to import the raw materials it needs – creating a supply chain shock.
How can firms protect supply chains from spikes in inflation?
INVERTO says it is vital for companies to closely monitor suppliers if they are based in countries with higher inflation. This includes actively planning for the risks posed to them by unstable currencies to help build more resilient supply chains.
INVERTO says that key steps companies can take to protect their supply chains from high inflation include:
- Closely monitoring the financial health of your suppliers. Look at more than just their balance sheet. This will help identify how well they will weather any shocks.
- Understand the supply chain of your supplier and how exposed it is to a weakening of their local currency. How many components does your supplier import? Does the supplier have the financial stability to pay for them, has he hedged the exchange rate?
- Implementing effective steps to limit liquidity risk. Suppliers in high inflation countries could quickly run into liquidity problems if their domestic customers are not able to pay on time due to currency devaluation. Having a diverse range of suppliers could be an effective hedge against this risk.
- Prioritise shorter term contracts with your supplier. Contracts should either be flexible to minimise price risk, or include index-based price escalation clauses, which will lead to price rises but these will end when prices stabilise. Shorter payment terms will also help the supplier’s financial health.
Nearshoring in Turkey
Turkey is an obvious example of the challenge. A key outsourcing destination, Turkey is an important part of the supply chain of many UK and European companies in the automotive, construction and broader manufacturing sectors.
Whilst inflation of the Lira has exceeded 60% for some time, companies do not want to move their supply chains out of Turkey. This is partly because of the costs of that disruption – and because Turkey has a reputation for skilled workers and high product quality.
Sushank Agarwal, Managing Director at INVERTO, says: “Despite the risks, suppliers in high-inflation countries remain key to many EU companies. This means it is vital for companies to monitor all aspects of their suppliers’ risks.”
“The case of Turkey illustrates why it can sometimes benefit companies to keep their supply chains in countries with high inflation, especially if they willing to take on additional risk. The benefit is accessing an experience workforce that delivers products to a very high standard – making the risk worthwhile.”
“Above all, communication with your supplier is key and makes the difference when conditions become too unstable. This allows both supplier and customer to navigate problems as they arise and find solutions much faster.”
What’s at stake if companies do not secure their supply chains agaisnt high inflation?
Sushank Agarwal adds: “A company’s own supply security could be at risk if they do not adequately address the risks posed by higher inflation to their suppliers.”
“High interest rates, for example in Turkey, mean that interim financing to help turn a struggling supplier around might not be easily accessed – making the financial due diligence of suppliers particularly important.”
*Source: IMF, September 2024. Countries with inflation above 25% are: Argentina, Egypt, Ethiopia, Iran, Malawi, Nigeria, Sierra Leone, South Sudan, Sudan, Turkey, Venezuela, Zimbabwe.
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