Want new sustainable product to be commercially viable? Don’t forget supply chain.
For new products, even sustainable ones, product-market fit is only one-half of the story. When we look at long term viability and scalability of new sustainable products, regardless of the nature of materials, be it virgin materials, waste re-utilisation, or value-added materials, it is important to adopt the right supply-chain strategy. Otherwise, a great sustainable product but poor pricing would not yield commercial viability.
Generally, in established markets/supply chains, the logistic cost is roughly 6% of the price of goods. The top two cost factors are (i) transportation which accounts for roughly 50% of the logistic cost, and (ii) inventory carrying which accounts for roughly 20% of the logistic cost.
Transportation of commercial/industrial goods are defined as Full Container Load (FCL) or Less Than Container Load (LCL). For every tonne of goods transported, the cost of LCL is at least twice the cost of FCL. It is not surprising that cost of LCL can be as high as four times the cost of FCL.
Using 6% as a rule of thumb, in order for any sustainable product to be commercially viable but lacking in volume to benefit from FCL, the price of good would have to significantly increase to account for higher cost of LCL. For the latter, the right strategy for sustainable product to be commercially viable is to find a niche market where the value of good is seen as less commoditised.
To benefit from FCL’s cost savings, we would likely be addressing more of a ‘commodity’ market that has volume. This is more scalable due to having larger end-user market. Another way of benefitting from scale that comes with FCL is to adopt a more centralised supply chain rather than decentralised supply chain, with the latter having to more frequently resort to LCL for order fulfilment, inevitably raising logistic cost.
1.1) Is futures contract necessary?
Some of the risks associated with commodity-type sustainable product (for example, animal feed) means that margin becomes thinner, whereby sourcing of raw materials is also that of the commodity market too. As such, this is susceptible to price fluctuation. Especially when innovative sustainable product inherently carries higher risk, such price fluctuation is even more undesirable. Therefore, engaging in the futures contract may be one way of minimising the risk expo-sure of price fluctuation of raw materials. One thing to bear in mind is that currency exchange can affect profitability across the supply chain (especially for cross-border trades).
2) Contract manufacturing
When a sustainable product is new and still developing traction in the demand market, the product owner is usually in a dilemma between developing its own internal manufacturing capabilities, and contract manufacturing. Developing internal manufacturing capabilities is very capital intensive, and in the early stages of product formulation, higher operating cost is usually unavoidable due to higher labour cost and less efficient manufacturing technologies. Contract manufacturing means engaging with certified manufacturer who has all the manufacturing infrastructure that the product owner lacks, whereby contract manufacturer is paid a certain amount of money by the product owner to manufacture an agreed quantity of product in a mutually agreed upon timeframe. It is usually the product owner’s responsibility to provide the necessary supplies to the contract manufacturer. The benefit of having own manufacturing capabilities is better safeguard of product IP, but comes with higher burden of cash-flow risk, especially if demand projection is still highly uncertain. Contract manufacturing significantly reduces cash-flow risk, but product owner may experience higher risk of IP exposure.
3) Acceptable Quality Limit
Assuming that ‘homogenous’ sourcing can be practised to reduce labour and capital costs in sorting, there is still cost involved in establishing and executing Acceptable Quality Limit (AQL) across the supply chain. In new and nascent markets (for example, alternative proteins) where supply chains can be dominated by start-ups, best practices and standards can be non-existent. Even if it is implemented internally within an individual organisation, these best practices and standards in AQL will not be uniform across the supply chain as vertical integration is unlikely to have occurred yet. These inevitable inefficiencies result in accumulation of costs that eventually pass on to end-users in the form of more expensive sustainable products.
COVID-19 has shown how our economic systems are still experiencing the domino effect as a result of disruption in global and/or regional supply chain. Sustainable products will not be an exception too. As we know, most consumptions are in cities, while raw material and intermediate goods are typically non-urban and external. This circumstance makes the implementation and execution of novel AQLs even more challenging, especially for resource-starved start-ups. Third party performance and quality monitoring will be required to mitigate for vested interest in buyer-seller dynamics. This monitoring has to be outsourced to SGS, TUV or NSF (SGS is typically for US market, TUV for EU market, and NSF for food). In decentralised supply chain, performance and quality monitoring can become increasingly costly, contrary to more centralised supply chains.
4) Duties, tariffs, and surcharges
If supply chain is transnational (inevitable for most products), duties, tariffs, and surcharges can become significant cost barriers in making sustainable products commercially viable. While duties and tariffs can be identified using HS Code, surcharges are sometimes not shown, typically an addition of extra charge on the agreed or stated price. These cost factors are non-negligible when it comes to commercial viability of sustainable products. Otherwise, most manufacturing is usually located as close to the supplies to reduce the cost of logistic pre- and post-manufacturing. With economic protectionism on the rise globally, this would likely translate to higher duty and tariffs.
One of the biggest risks in supply chain is over-reliance on a key stakeholder (important supplier). This has its own inherent risk in supply chain disruption should the key supplier’s flow of goods become interrupted. When optimising between risk exposure and commercial efficiency, the reality is that a viable supply chain will likely be somewhere in between the spectrum of decentralised-centralised networks. While not all the aforementioned factors are of immediate concerns, especially for start-ups focused on sustainable products; if we want to practise viable sustainability for the long term, these factors cannot be discounted.
“This article is written in collaboration with Ms. Hsuen-Kuan Yong. I would like to sincerely thank her for 10-year plus of accumulated knowledge of global supply chain”