How Do Recessions Impact Supply Chains?

How do recessions impact supply chains? This article will discuss how an uncertain recession can become a supply chain’s worst enemy and how an actual recession could increase uncertainty in the short term.

The impact of other factors caused by fully developed recessions will be discussed as well. Read further to learn about the real-world effects that soon may follow.

How Do Recessions Impact Supply Chains? How Do Supply Chains Work?

High-functioning supply chain teams operate like this:

1. Demand planners make a forecast based on recent buying trends, seasonality and any new products or promotions that are being introduced.
2. Based on the demand plan, the supply planning or inventory management teams make a plan for volume and types of supplies to order from vendors.
3. The procurement team of a purchaser orders these goods. As the supplies arrive, the manufacturing team builds the product.
4. Throughout the process, the logistics team ensures the materials are arriving on-time and customer care makes sure the buyer is aware of the delivery date and any delays.

How Do Recessions Impact Supply Chains? Small Disruptions Become Large Problems

The last two years, supply chains and risk management have been in the same, consistent headlines: supply chains cannot keep up with demand.

At first, many of the stock outs, also known as out-of-stock situations, were clearly related to the urgent demand, or exigencies, of pandemic-driven needs for toilet paper, disinfectant and canned goods. But fairly quickly, additional effects took hold and the shortages became more comprehensive and unpredictable for goods such as furniture, computer chips and building supplies.

Ultimately, the multiplicity and endurance of these shortages began to drive sharp pricing increases, resulting in inflation across the globe. This is displayed in the United States where we are currently witnessing the worst inflationary period in the last 40+ years.

How Do Recessions Impact Supply Chains? Can a Recession Possibly Help?

A common idea is that a recession might actually be a good thing for supply chain disruption. The reasoning is that a recession could help because the letup in demand would give supply chains time to catch up. In turn, this would have positive effects for businesses in general.

There is an appealing logic to this line of thinking. If too much demand and not enough supply caused all the supply chain problems and drove inflation, then less demand due to recession should allow supply chain shortages to be remediated. Unfortunately, as with many things supply-chain related, the reality is more complex.

Demand Is the Driver

A major flaw in the reasoning why a recession will help supply chains is that no one really knows if demand will slow down. To be sure, steady or rising demand may be a good thing for businesses, but it can quickly become a problem if supply chains are not prepared. And supply chain leaders need to be prepared either way.

In addition to all the on-going challenges, supply chain leaders must be wary of a drop in demand. There are signs of a recession, which is defined as two consecutive quarters of negative gross domestic product (GDP). In this case, one would expect higher prices to compress purchasing power enough to cause a pullback in consumer spending. However, actual demand decreases currently are spotty.

This situation puts supply-chain leaders in an extremely precarious position. Does a business start lowering inventories based on the assumption of reduced demand in the future? If demand falls, will a merchant get stuck holding/storing/reducing price on surplus. If demand does not decrease, businesses may run out of stock, miss maximizing revenue, upset customers and lose market share.

Given the pain of missing either side, for most companies the natural thing to do is to maintain the status quo until there’s a clear reason to do otherwise. Unfortunately, as the pandemic has shown, this approach tends to fall short, especially when uncertainty rattles supply chains across their multiple interdependent processes.

How do Recessions Impact Supply Chains? Additional Ways 

Soaring to Lower Prices

Supply chain shocks and shortages have resulted in rapidly soaring prices. However, an economic downturn will bring a decrease in demand. Therefore, prices will lower closer to a stable equilibrium.

Lower prices will have a significant impact on the supply chain, severely cutting into the profitability of all involved companies. Margins will be squeezed dramatically all the way from the supply end to the retail side, as retailers find themselves unable to sell the same items for the same amount. In turn, this will impact distributors, suppliers and producers causing all entities to see a dent in their profits.

Important Resources

Reducing costs is not the only thing supply chains should be thinking about. Resources such as raw material and energy will also need to be optimized. Companies that make the most efficient use of these important resources will maximize the profitability they are able to see in challenging times.

With energy prices at an all-time high, and likely to remain that way, these resources can put particular strain on any manufacturer’s budget. Companies that have a way to optimize their use of energy and can maintain a lean, efficient supply chain without wasting resources are more likely to emerge unscathed from a downturn.

Labor Shortage

Companies are struggling to fill the vital role that they need to keep plants running. It is a job seeker’s market and that is true for manufacturing as well, as the sector struggles to tackle ongoing problems with hiring and retention.

However, if an economic downturn occurs, factories lagging in employment could see an increase in applications. Typically in a recession, it becomes easier to recruit people, especially for these operational jobs that are vital to keep supply chains running smoothly. With the economy declining and the job possibilities slowly disappearing, more workers could return to manufacturing operational roles as a stable source of employment.

How Do Recessions Impact Supply Chain? The Bottom Line

Recessions theoretically can help supply chains in the form of decreased demand and labor retention. Yet, a recession can cut profits due to the lowering of prices and the need to invest in important resources to weather a downturn.

However, the current economic conditions make solving supply chain issues extremely difficult. Due to the uncertainty of whether or not the economy will enter into a full recession with all of the effects that come with it, planners must hover in the middle of optimism and pessimism.In turn, this has created an issue with shortages as demand in the future is very much uncertain.