Persevering through supply chain disturbances

One effect of the coronavirus pandemic has been supply chain disturbances felt around the world. From shelves empty of toilet paper and cleaning supplies early in the pandemic to a shortage of Christmas trees last December, the pandemic illustrated just how difficult it can be for suppliers to turn on a dime when demand suddenly shifts.

Commodity prices have fluctuated wildly while factories and ports have undergone COVID-19-related shutdowns and shipping container prices spiked.

“All these things just happened all at once,” said Jana Kelly, CPA, an independent supply chain consultant with Sapphire Road Solutions in Dallas. “In the past maybe we had a port shut down because of some issue, maybe a ship got stuck in a channel, but everything else was working. Now it’s everything falling apart, all randomly, random places, random timing. It was very hard to anticipate.” (See the sidebar, “Prepare for the Worst in Your Supply Chain.”)

Arguably the most deeply affected sector has been the lumber market. Over the course of a year, lumber prices more than quadrupled, spiking in May 2021 at $1,686 per thousand board feet. Prices have dropped from that peak but remain variable, and analysts say it may be quite some time before they settle back to pre-pandemic levels, if they do at all.

Industries across the board have been affected by those rising prices, but none as greatly as homebuilding. Many homebuilders scrambled to pay their bills without passing the increased cost on to customers, but home prices wound up rising significantly. According to the National Association of Home Builders, the growth in lumber prices added about $30,000 to the average price of a new single-family home in the United States.

In some cases, the challenge wasn’t a matter of increased cost: Builders simply couldn’t get enough of particular materials such as OSB, a plywood-like board widely used for floors, walls, and roofs.

“For us, this has been pretty big,” said Mark Woudstra, CPA (Inactive), the CFO of Eastbrook Homes in western Michigan. In 2019, he said, lumber was 8.5% of the hard cost of a basic house Eastbrook builds; in 2021, it was 16.3%. The company, which has 110 direct employees, agrees on home prices with customers before the houses are built, which means that when lumber prices swelled dramatically over the course of three months, Eastbrook largely had to bear the brunt of a much more expensive home.

“We’ve never had this problem before — a raw material that’s so important to the homebuilding business, rising so fast and spiraling out of control,” he said.

To manage and offset some of those rising prices, Woudstra and his company have employed a range of strategies. These tactics can also be of use to other accounting and finance professionals facing supply chain disturbances themselves — whether they’re linked to volatile lumber prices or to other vital materials like steel, whose price is rising as the global economy gets back on its feet.

Carefully examine use of materials

The most obvious approach, Woudstra said, would be to determine whether cheaper and more available materials could act as a substitute for lumber. But in homebuilding, he said, lumber tends to be foundational in framing a house; there’s often nothing else that can work in its place.

So instead, the company has carefully examined its house designs to make sure that no wood is being lost during construction.

“We value-engineer every plan to use the least amount of materials,” Woudstra said. The company has also paid particular attention to its workers, ensuring that they don’t waste any of the lumber. “We want to make sure our framers know how to use the materials correctly, not cutting a 2-by-4-by-10 into a 2-by-4-by-8.”

Boost inventory

In the past, Eastbrook rarely bought materials without knowing exactly where and when they would be used. “We didn’t ever hold any inventory on the books,” Woudstra said. But that only works when the worldwide supply chain is functioning smoothly. With prices rising so fast and some materials potentially becoming very hard to procure, Eastbrook has been buying crucial materials ahead of time to ensure the company can complete its projects. “We don’t want a house that’s only halfway complete because you can’t get a roof on it.”

But more inventory creates an increased carrying cost, which brings with it additional risk. And it requires storage space. Eastbrook hasn’t bought any new facilities; so far, it has been strategically locating extra inventory at its in-progress developments.

“We might have an empty lot, so we’ll say, ‘Let’s just put some extra OSB on this lot,'” Woudstra said. But that’s not sustainable for a long period: The wood might warp, and the materials are vulnerable to theft.

Kelly said that, for some companies, boosting inventory is a goal that might not be realized until the current pandemic-panicked environment calms.

“There’s probably not a whole lot of companies that have a lot of stock sitting in warehouses waiting on orders,” she said. “Products are being ordered as fast as they are coming in. And it’s going to take a long time to unravel that to get back to having safety stock.”

Be strategic about purchasing

Like many other builders, Eastbrook often buys its wood at set prices, something Woudstra called a “lumber lock.” Distributors and builders negotiate a set price for lumber that’s good for a specific period — say, 90 days. Usually, that price predictability makes good business sense for both seller and buyer. But with lumber prices so high, Eastbrook’s distributors became reluctant to lock in prices for such a long period; instead, they limited the lumber lock to a few weeks, putting much more risk on builders’ shoulders.

In response, Woudstra and his colleagues watched lumber prices carefully daily to decide when to lock in a price. And they also joined with several other homebuilding companies to create a purchasing group, something that gives small builders more clout when buying from a large lumber mill. Instead of individually needing enough lumber to build 500 homes, for example, the group might be collectively building 3,500 homes — which means a much bigger lumber order, and much more purchasing power to negotiate favorable prices.

But the world of lumber purchases isn’t all hard-boiled negotiations. Woudstra added that it’s also key to remain on good terms with suppliers and to communicate with them frequently.

“They’ve been partners of ours for years, and we have good, long-standing relationships with them,” he explained. “We helped a lot of them survive through the past downturn, paying quickly and timely, and we think that helps.” After all, the next time there’s a crisis, the tables could be turned.

Some suppliers may find that commodity prices spiked so dramatically that they will go bankrupt if they deliver goods to their customers at the contracted prices. In those cases, Kelly said, it may be necessary to renegotiate with suppliers because everybody loses if the supplier goes out of business while trying to honor its contracts.

“Come up with ways to temporarily alleviate some of that pain,” she said. “Maybe you build into your purchase order some flexibility around the pricing so, if the commodity increases by more than X percent, we’d renegotiate the purchase order. It’s still guaranteed. Wherever it was in your list for production, I still hold my slot. But I’m willing to pay more.”

Think long term

Some smaller builders use a cost-plus pricing model, charging a specific percentage above what the company pays on raw materials. But Eastbrook Homes builds its houses on a fixed contract: A home’s price is agreed upon before the house is built. What that means, ultimately, is that Eastbrook takes a risk that materials won’t cost more a few months later, when the house is under construction.

In this case, with lumber costs skyrocketing month after month, the company’s margins shrank. But Eastbrook chose not to adjust home prices after contracts had been signed. “For now, we’ve been honoring our pricing but have been looking into it,” Woudstra said. That could strengthen the company’s reputation, though Woudstra admits, “We’ll have a bigger margin compression with this.”

But Eastbrook has been around for over 50 years and is in a fairly good equity position. It can withstand some tough times.

“As a company, we run pretty conservative, fiscally,” Woudstra said. “We can take some hits on margin and be OK.”

And now with lumber prices dropping, Eastbrook could finally benefit. In 2020, the company closed 375 homes; it is on track to close 475 homes in 2021. Eastbrook has held steady and continued with its fixed contracts, which means in a few months, it might just begin to recoup its losses.

About the author

Amanda Abrams is a freelance writer based in North Carolina. Ken Tysiac, the JofA’s editorial director, contributed to this report.To comment on this article or to suggest an idea for another article, contact Drew Adamek, a JofA senior editor, at Andrew.Adamek@aicpa-cima.com.

Prepare for the worst in your supply chain

Clients often tell supply chain consultant Jana Kelly, CPA, that they hope pandemic-related supply disruptions will disappear in a month or two.

Kelly tells them instead to prepare for the worst. “You can’t live on hope,” said Kelly, who heads her own Sapphire Road Solutions consulting firm in Dallas. “You can’t hope tomorrow is better or next month is better. You’ve got to assume this isn’t going away for probably a year and a half. So, what are you going to do differently?”Here are some of Kelly’s tips for managing supply chains at this difficult time.

Use multiple suppliers from different countries

If all your suppliers are in China, for example, you are susceptible to a shortage if a spike in coronavirus cases occurs there.If you must have multiple suppliers from the same country, it may be a good idea to make sure they use different ports in case one of the ports shuts down. Nearshoring (Mexico may be a good alternative for U.S. companies) or even using suppliers from inside your own country is another option.”For some companies that’s probably easier than for others,” Kelly said, “but it certainly should be considered.”

Consider analytics carefully

Companies that integrate holistic supply chain management systems into their ERP systems can get tremendous value from predictive data analytics and automated alerts.But the pandemic environment is so different from anything that existed before that the predictive value of algorithms based on history might be limited. And after COVID-19 subsides, data from the pandemic period might not apply to the future.”When those algorithms and that system are looking back at 2021, 2020, the numbers will be all over the place,” Kelly said. “Those are not going to be valid trends that really help you predict.”

Be wary of overconfident suppliers

If a supplier is promising extra capacity, it’s important to determine whether they can keep their word. Are they opening a new facility? Adding new lines? Hiring more people?”There are a lot of questions that should be asked and commitments made with the suppliers so that you can feel confident something is going to get better,” Kelly said.

Boards need to know the details

It’s not enough for management to tell the board that they have a backup plan.”I think they should be asking, ‘What are the additional measures you’ve put in place?'” Kelly said.

— By Ken Tysiac, the JofA‘s editorial director.

AICPA RESOURCES

Articles

“Interruption of LIFO Inventories Due to COVID-19 and Sec. 473 Relief,” JofA, Aug. 23, 2021

“From the Filings: Supply Chain Lessons From the Pandemic,” JofA, Feb. 18, 2021

“Capex Risk Management During the Coronavirus Pandemic,” JofA, Dec. 2020

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