Supply Source Shrinkage

(Photo by Kedar Diwakar Mandakhalikar at Scopio)

Modern societies, and for that matter modern large businesses, are highly complex systems. Pluck a strand somewhere and the vibrations can reverberate in multiple places, perhaps in unexpected ways.

At midweek, Heather Cox Richardson noted President Biden issued an executive order last summer that has been overlooked by the public. The order noted the rise of mega-companies, the resulting rise in inequality and dampening of competition. Biden established a White House Competition Council to look at relevant concerns from the perspective of each federal government department and consider what to do about them. Heather highlighted the military’s view:

[The] Department of Defense […] noted that since the 1990s, the defense sector has consolidated from 51 to 5 defense contractors. This is a national security issue, it said, since lack of competition means higher prices for the government, slows innovation, and risks supply chains. The report calls for encouraging new businesses, broadening the supply chain, and overseeing mergers more carefully. The Defense Department called for the government as a whole to increase domestic capacity, expand supply chains, and build the workforce to reduce the reliance of our national defense on a few contractors.

Shrunken Lists of Suppliers

Businesses have undergone similar shrinkage in vendor lists.

Sometimes it is inflicted by external factors we cannot control. Perhaps when I opened my factory, the raw material for my widgets was available from ten suppliers. Over time, the biggest suppliers acquired the smallest ones. Now there are only two suppliers for the material I need. They don’t need to overtly collude with each other in order to have the same effect as illegal price-fixing. Whenever one raises its prices, the other soon follows. They can raise prices on a whim, simply because they feel like getting more money. Competition has been decimated. I am stuck with higher costs because no one remains in that market with an incentive to keep their profit margin reasonable.

This affects individuals too. For example, in the USA, the disposable diaper market is dominated by only two companies: Proctor & Gamble and Kimberley-Clark. The same dynamic applies. There aren’t enough suppliers in the market for competition to limit their price increases or their profit margins. They can wring as much out of new parents as they want.

At other times, vendor list shrinkage is self-inflicted.

Many large companies decided years ago that it would be easier to deal with fewer suppliers. They would shave a few dollars off administrative costs by having fewer contracts to handle and fewer invoices to pay. Up to the middle 1980s, they were willing to do business with many independent contractors doing such things as computer programming and engineering. Staffing firms used the passage of Section 1706 in the USA tax code and IR35 in the UK (ten years later) as leverage to convince companies that they needed to force all such contractors to go through a staffing company. Next, they persuaded companies to limit their list of acceptable staffing companies to a handful on a Preferred Vendor List. The staffing companies took anywhere from 10% to 40% of billings to a subcontractor, 60% to workers who agreed to be put on the staffing firm’s payroll as a temporary employee. (Those figures are from my personal experience with that market.) Over time, the staffing firm’s portion sometimes became even larger. Either the contractor had to take a substantial cut in income, or the company using their services had to pay a lot more for their work if their previous rate was going to filter through to them.

It isn’t always that complicated. Sometimes a vendor list shrinkage is simpler, such as deciding to buy XYZ from only the favorite few out of a much longer list of available suppliers. I have often seen reductions from 10 or 20 vendors to 2 or 3.

Ripple Effects

In both the external factor scenario and the self-inflicted vendor list shrinkage scenario, the customer ends up paying more for the same product or service. This cost escalation can be due to no longer having prices constrained by competitive pressure, or due to costs added by a consolidator such as the staffing firms, or both.

But money is not really the most important factor. Both scenarios also put the customer at increased risk. There is no such thing as full production all the time. Sooner or later, something goes wrong and with a narrowed supply funnel, that’s enough to pull the rug out from beneath you… as an individual customer, or a business, or a military, or a national health system, or whatever type of customer you are.

Big Picture versus Local Picture

As the Competition Council gets reports from more government departments, more detail along these lines will emerge. Let the Council develop recommendations for national policy.

In the meantime, we can take a look at our own situations to see whether we are in a corner ourselves. If so, we can start searching for ways out of it.

As an example, we all know dependence on fossil fuels puts us in a bind. The price swings wildly. The UK, where I live, has to import much of its fuel. Household heating bills have gone up hugely (50% increase is not unusual), will go up more in April and again in October as the regulatory price cap increases.

But relying on huge wind farms and solar fields to transition to renewable energy only addresses this on a large scale, not at the level of a household or a business. Many places have old-style conventional electric distribution grids that do not cope well with much fluctuation in demand or supply. The Texas grid is a glaring example. People died when it failed last winter and parts of it went down again recently. Much of the UK grid is also inflexible. The ideal is a modern smart grid like Chattanooga, Tennessee, which adapts itself readily to changing conditions. Few places have invested in a full upgrade like that.

We aren’t necessarily at the mercy of a fragile electric grid if we have enough resources to invest in localized generation of electricity.

I’ve mentioned a local independent supermarket before. Stans is magically able to offer a little of practically everything the village might need on a day to day basis. Food, pharmacy, haircuts, Wellington boots, gardening supplies, floral bouquets, dry cleaning, pet supplies… It needs reliable lighting and refrigeration to stay open and keep chilled foods at the right temperature. That requires a lot of energy. A significant power outage would be disastrous for the store.

Half of its large roof is covered with solar power panels.

We’ve been gathering proposals for a solar power system at our house, and I suspect our motivation is a lot like Stans’.

Most of the suppliers pitch to us about how much we can save on energy bills, the number of years it will take for the system to “pay for itself” in savings and a small amount we can collect from a utility company by selling them energy we don’t use (at about a quarter of the rate they will charge to sell it on to someone else), and how much we’ll be financially ahead in the long run.

(Side note: They typically forget to include such details as the cost of replacing the inverter midway to the “paid for itself” point. Most look stunned when I ask about the type of battery storage they want to use and why they choose that instead of a less costly technology which lasts for more recharge cycles. Asking questions can uncover better solutions.)

For us, it isn’t entirely about money. Energy security is more important. It’s about protecting the household from the possibility of an electric distribution grid that may become less reliable. Energy is a potential pinch point in supply to our household. We’re in a corner about that. We’d like to maneuver ourselves out of that corner.

As everyone looks for ways to emerge from a highly disruptive couple of years, let’s not try to simply go back to the way we did things in 2019. Let’s see if we’re boxed anywhere and find a way to arrange better options.