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Heightened fears of recession following activity in the bond market

Economic prosperity has stretched into its 10th year, which is something to celebrate. But this lengthy period of growth has been met with skepticism. During the last several months, economists have been following several indicators of economic depression to determine when the next one might strike. One of those indicators is the inversion of the yield curve, which happened in late March 2019. When the yield curve is inverted, short-term interest rates are higher than long-term rates. This causes payments on adjustable-rate mortgages to rise and credit lines tighten. As borrowing becomes more difficult for consumers, they are less likely to make major investments.

Historically, the housing market has been heavily impacted by these trends. When consumers stray from homebuying in favor of rentals, building activity slows and the construction sector eventually takes a hit. In 2019, the number of housing starts has yet to return to pre-recessionary levels. Moreover, U.S. homebuilding dropped to a two-year low in March. Pricey inputs and labor shortages have been preventing builders from constructing affordable homes for buyers on the lower end of the market, placing some downward pressure on homebuilding activity.

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How can procurement deal with economic downturns?

Should the United States slide into another economic recession or depression, procurement departments across the board will be feeling the pressure to redefine contracts and make smarter purchases. While sluggish demand for construction work may mean sourcing fewer goods, procurement professionals’ jobs are more important than ever during recessionary periods. As cost-cutting techniques become even more important, procurement departments may need to take a more hands-on approach.

One of the major concerns for any firm operating during a recession should be waste. Construction firms in particular are at risk of discarding salvageable building materials, misplacing tools and equipment or improperly storing excess inventory. As the pressure to cut costs builds during recessionary periods, procurement departments can prove their worth by taking a stronger role in helping to control inventory and avoid waste.

Construction firms need flexible contracts

Recently, ProcurementIQ published an article which mentioned the benefits of long-term contracts in the transportation sector to help control input cost volatility. Although buyers in the construction sector also procure volatile inputs, long-term contracts are too inflexible for many construction firms. This poses major issues when building activity slows during recessions and fewer construction materials are needed. Let’s look at what buyers can do to secure recession-friendly contracts that work to reduce waste.

Avoid excess inventory

When procuring the building materials that are most commonly used in their projects, construction firms may consider entering long-term contracts with suppliers or selecting providers with minimum order quantities (MOQ) that offer reduced per-unit prices. While it may look like these supply contracts will help buyers save, buyers should put safeguards in place when possible to avoid having to store excess inventory. Excess inventory can be expensive to warehouse and therefore may undo any savings achieved through bulk purchasing. Unnecessary warehousing costs are especially problematic during recessionary periods when firms’ budgets tighten to preserve profit margins.

Beware of supply shortages

Shifting toward a more transactional agreement with suppliers can help reduce the risk of storage fees, but short-term contracts come with their own risks. One of the major risks that buyers face under transactional relationships is the potential for supply shortages. With long-term contracts, vendors can ramp up production in order to produce a steady stream of goods for their buyers. However, transactional relationships require less preparation on the part of the supplier. Their ability to scale up according to sporadic ordering is limited. In turn, buyers engaged in short-term agreements may face longer lead times when they make ad hoc purchases because suppliers may not have the resources necessary to quickly and efficiently fulfill orders.

Smart procurement without the shortages

While the recession hits some sectors of the economy immediately, the construction sector usually undergoes some lag time. Economic prosperity often fuels building activity, giving construction firms plenty of work. Once the economy slows, construction firms rely on the backlog of projects that flooded in during the former growth period. That said, the effects of the recession eventually burden construction firms, leading to a slow recovery for operators across the sector.

In planning for a future recession, procurement professionals at construction firms can seek out flexible contracts with suppliers that help reduce the need for storage. To shift some of the responsibility onto suppliers, buyers may able to secure a vendor managed inventory (VMI) agreement. Under such agreements, vendors store and oversee buyers’ inventory. This allows the vendor to slow or hasten production as necessary. While these agreements typically come at a higher cost up front, long-term savings on warehousing fees often offset the initial price hike.

 

By: Kim Bucci, Business Research Analyst

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