Going Green in European Supply Chains

Although green pressure groups have been around for a long time, Al Gore's movie "An Inconvenient Truth" in 2005 was the first statement in this area that shocked audiences worldwide and made them realize the importance of having an opinion on this subject. Supply Chains are typically global in both reach and impact, thus they offer highly visible areas where important gains can be won when it comes to sustainability. Yet prior to 2005, developments toward greener logistics and supply chains were still moving at a snail's pace. Many companies found it fashionable to incorporate it as part of their social responsibility mission statement but only a few companies really invested in it around 2005.

Two developments have tipped the scale in Europe and put it in capital letters on corporate agendas. The current recession has added a heavy hitter in the game. Due to substantial government investments made in order to keep their economies going, governments in Europe are now without a doubt in the driver's seat. This has provided them with a vehicle by which they can accelerate the implementation of their own agendas, and sustainability unequivocally happens to be on the top of most lists. Accordingly, governments and green lobby groups are stepping up the pressuring on corporations to reduce CO2 footprints and some avant-garde corporations are already wisely maneuvering to use the issue as a competitive advantage. In the not to distant future the lack of sustainability will become a dissatisfier. The second development was the rapid climb in energy prices in 2007/2008. While somewhat temporarily abated, this event has served to dramatically draw corporate focus to the reduction of their energy consumption, which has the added immediate benefit of driving down transportation and operating costs.

One doesn't have to look far in Europe to witness numerous examples illustrating the green movement in supply chains. In the UK a label for groceries has been developed that shows in a boarding ticket style the origin of the product and the amount of CO2 related to transporting the product ( e.g. apples or kiwis) from the point of origin to the grocery store. This serves to educate the consumer and empowers them to affect change. Our own experience in distribution network studies buttresses the notion that the CO2 footprint criteria is gaining fast in importance. France is preparing laws that will dictate that with every shipment the CO2 output will need to be shown on the invoice.

In the recent past, investors were generally only focusing on their fixed investment costs rather than facility running costs. That was a concern more or less for the tenant. It's not enough any longer to just build boxes that meet structural guidelines (e.g. floor flatness) and adher to safety and building codes (e.g. sprinkler systems, wiring, etc.). Instead, investors in new warehouse real estate now need to focus on technology and building techniques for facilities that will promote energy conservation and sustainable materials usage as keys to insure that they will be able to find tenants for their warehouses ten years out in the future.

If developments in sustainability keep at the current pace, companies operating in Europe need to be sure that they get on the bandwagon in time.  If they don't they shouldn't be surprised to wake up one day and discover that it is dramatically affecting their business or that they are even going out of business!     

I was recently in a meeting with a senior corporate supply chain manager who told me that his company had the intention to start selling its products in Europe. He showed me some plots of expected customer densities. He had obtained a European map depicting the "blue banana", a region which represents the heart of all trade flows, where most of the customers, wealth and industry in Europe are clustered. They were looking for a site location for their proposed European distribution center only within this specific region.

 

He prompted me several times for my opinion as to where that I would recommend they locate within this specific region. I responded that it wasn't so cut and dry. Instead of giving him my opinion in response to his question, I asked him some probing questions in return which triggered him to go back and do some additional research, such as:

Do you know which countries (e.g. The Netherlands) provide tax ruling, whereby you only have to pay VAT duties once you have sold your products? That could save you substantial funds in the long-run since you won't have to prefinance your taxes.  

Did you consider whether it might be advantageous to assemble your products in Europe? Import duties on sub-assemblies for some products are far less than import duties on the final products. For example, one electronics sector company brings in sub-assemblies in from Asia and then assembles them in Poland, thereby saving 14% on import duties.

Are you aware of local subsidies / incentives to settle in non-hot spot areas? These could influence your business case for a preferred location. You need to be keenly aware of specific subsidies that might be available in these less popular locations; e.g., reduced square meter price for land, temporary reductions in employment taxes, tax holidays, etc. All of these can add up and can be very financially beneficial. Such costs savings can be critical in the initial European market penetration as your fixed costs are spread over fewer sales.   

Needless to say that there are numerous other issues impacting your supply chain footprint in Europe and its overall costs. Site location is one that you typically have to live with for a significant number of years and one that can have a major impact on your initial investments and running operational costs. It's essential to recognize that both EU and country specific rulings and regulations can greatly influence your supply chain costs. It's easy to follow the herd instinct and follow your competitors to the prevailing popular locations, but that can be a costly pitfall. Try to avoid entering the site location process with a preference to just follow what is trendy with the industry; instead, do your own thorough analysis and calculations trying hard to avoid entering the process with preconceived notions. On the other hand, be cautious about arriving at site location decisions that are solely financially beneficial in the short-run but won't meet the needs of your business model in the intermediate and long-run.   

As a result of today's economic crisis numerous companies throughout Europe are scrabbling to identify various means to reduce their operational costs.  Inasmuch as the supply chain is the linking pin between the different company processes of production, sales, marketing and purchasing, the supply chain accordingly plays a vital role towards the achievement of these costs savings.  Unfortunately, the typical supply chains solutions that I so often see implemented are rather knee jerk and can have a converse effect, even from a short-term perspective, but especially when viewed in the intermediate-and long-term.  This of course is not exclusive to companies operating just in Europe but can be witnessed globally among companies operating internationally.

One of the first supply chain measures frequently implemented is the reduction in inventory levels (even greater than the actual demand drop), i.e. reduce working capital.  On a company level this is generally considered as a financially effective, practical and agile response.  However, if one reviews this measure on a multi-company supply chain network level, it has a different effect.  On top of the actual demand reduction in the market, the upstream supplier of raw materials is confronted with an additional demand fall because its B-2-B customer is also actively reducing its inventory.  Because this effect accumulates upstream, companies at the start of the supply-demand chain can experience tens of percent demand reduction in a period of just weeks.  In my opinion this is one of the reasons why the chemicals industry is hit so hard by the recession, being the early source of most supply- & demand networks.

Another easy gain that supply chain professionals typically pursue during a recession is a cut down on the day-to-day cost of transportation.  Logistics Service Providers (LSP's) are confronted with companies conducting all kinds of logistics tender procedures with the sole objective to renegotiate their current transport rates and find the cheapest LSP.  Shippers have the opportunity because of the on hand surplus in transportation capacity during a recession.  This transport rate erosion however is disastrous for the quality of the transportation- & warehousing sector in the mid- & long-term.  The already small profit margins in the transportation sector leave no room to any further extent for structural investments in transport quality- & efficiency.  This is especially troubling when one considers the fact that in some industry sectors in Europe over 60% of companies outsource logistics activities.  In the long-term such a logistics standstill could cost shippers more than the short-term savings.

Today's supply chains have developed from single line logistics supply chains to international, global supply- & demand networks.  Product sourcing is done from different continents, competitors are used as co-packers or perhaps the customer manufactures as well for its supplier.  Suppliers have a far going logistics dependency with their customers through concepts as Vendor Managed Inventory and different supply chain structures are operated within the same company for each individual product/market combination.  In such complex network structures there are no simple one-company solutions anymore.

Supply chain professionals should especially understand this and prevent sub-optimization during a recession by thinking in terms of multi-user networks and long-term partnerships. Ultimately the cost savings you realize  as an individual company are only as big as the savings of the weakest link in the supply-demand network that you are part of.  In these economically challenging times this kind of an approach takes courage and a multi-disciplinary vision.  If there is one business discipline which should (already) have adopted this management vision, it is Supply Chain Management.  No doubt tough economic times sometime dictate tough decisions, but supply chain professional must be careful to avoid the silo mentality that so often takes place in the other functional areas of corporations.  If anyone should have the big picture, it should be the supply chain professional.

How will a partial shift away from offshoring impact the structure of European warehousing?

It was recently reported in the Financial Times that Philips, one of Europe's largest electronics manufacturers, has developed strategic plans to shorten its supply chain by producing closer to the market. To accomplish this, Philips plans to increase production capacities in Mexico and Ukraine to supply the respective markets in the USA and Europe, at the cost of China and Malaysia. However, Philips is by no means alone in such a strategic shift to one of more onshoring/nearshoring of production. Companies like Adidas and Boeing now tend to produce and/or buy closer to the market.

So what's causing this break with offshoring? Actually, there are several arguments. In today's world a number of factors make the balance more beneficial for producing regionally or even locally instead of globally. Not only have wages increased dramatically in e.g. China in the last years, (overseas) transport costs have increased significantly as well, notwithstanding the fact that cost of capital-in-transit remains more than ever an ongoing financial burden for so many cash strapped companies. Moreover, with an ever increasing customer service driven mentality, time-to-market has become a very hot issue in today's global supply chains and competitive markets. The long reorder cycles associated with offshore production make it difficult to be flexible and responsive to customer needs. Companies continue to also struggle with intellectual property theft with production in less developed markets. And last but not least, due to EU regulations and a dramatic change in the European public mindset more and more companies  are choosing to place their CO2 footprint in a strategic market perspective. Needless to say that supply chains based on offshoring  turn out to be less favorable when cast in this light.

So what effect, if any, would enhanced onshoring/nearshoring strategies have on the structure of European warehousing? Most likely it would have a major impact. In Europe, the trend since the expansion of the EU in 2004 has already been to move labor-intensive onshore production facilities to the CEE region (Central Eastern Europe) and the adjoining Asian countries. A partial shift away from offshoring would only accelerate this trend. Because more products would be produced closer to the market the number of direct shipments directly from the source to the customer would increase. This would not only be beneficial for the CO2 footprint, but it would also be cost efficient. A side effect would be a shift in storage needs across Europe. That is, because volumes that used to be shipped via warehouses in Western Europe (the customer's region) would instead be shipped via (plant) warehouses in the CEE. Consequently, the required storage space (and hence costs) would likely increase substantially in the CEE. Finally, because of this shift in production locations the Center of Gravity would shift eastward. This would result in more European distribution centers (EDC) moving eastward and more regional distribution centers (RDC) installed throughout Western Europe.   

It's not a question as to if this will occur, but only how fast. We aren't seeing a Tsunami yet, but a definite trend is emerging, especially in certain sectors like the Electronics industry. With energy prices expected to climb rapidly in outlying years, with continuous government pressure to reduce corporate CO2 footprints and ever increasing labor costs in major offshoring locations, increasing numbers of European firms will be forced to shift to greater onshore/nearshore  production. No doubt, this trend will fuel a gradual realignment in the structure of European warehousing.