At one time the factory in Denmark was run by the pharmaceutical company Novo Nordisk A / S (ADR: NGO) makes up half of the world’s insulin reserves. Promising never to miss the product on which people’s lives depended, Novo kept a five-year supply in deep freeze.
Few companies will take such measures to maintain optimal stock levels. However, the anecdote is instructive, especially in light of recent events: while creating stability in supply chains must pay a price, for failing to do so the price is even higher.
The debate will continue long after giant baby formula maker Abbott (NYSE: ABT) is fully resuming production at its plant in Sturgis, Michigan, the nation’s largest infant formula company. The plant was closed in February after regulators began investigating a possible link between the mixture produced there and a number of childhood bacterial infections and two deaths. Abbott, which accounts for nearly half of all formulas consumed in the U.S., has also announced a voluntary recall of its general-purpose and metabolic formulas, the latter designed for children with mental and physical disabilities.
On Monday, Abbott Park, Illinois, and the Food and Drug Administration entered into an agreement of consent allowing Abbott to resume work at Sturgis within two weeks of signing the FDA. Once the site is restarted – and there is no schedule for it yet – it will take six to eight weeks before the product will be available on store shelves, Abbott said.
Abbott, meanwhile, operates daily air travel to the U.S. from its plant in Ireland. The White House is also seeking to ease restrictions on the flow of foreign imports, which is actually becoming anti-competitive due to high tariffs. About 98% of the American formula is consumed domestically. Four companies control about 90% of the US market.
It’s hard to imagine a product with a profile so consistent with the sustainability model. Baby formula is essential for health. Formulas are perishable and difficult to produce. Not surprisingly, inventory turnover is quite high. According to current Census Bureau data, inventories of infant formulas are wrapped an average of 25 times a year when using sales data as a benchmark. Turnovers are reduced to 13 times a year when the cost of materials is used in the calculation.
There is a sharp concentration of the market. According to the 2017 census, 13 facilities of the four leading manufacturers accounted for 45.2% of the cost of supplies of infant formula. The status quo is exacerbated by trade barriers that hinder foreign competition. In addition, trade barriers continue to hinder foreign competition.
Add to this a drop in supplies caused by product accumulation and supply chain disruptions as a result of the COVID-19 pandemic, and it’s hard to imagine why no alternative manufacturing units have yet been set up to prevent one factory from getting so much slack out of the system.
Manufacturers of infant formula “should not have a single point of failure,” said in an interview Tuesday, Willie Shea, a professor of management practice at Harvard Business School Robert and Jane Sisick. “Companies should be able to split production between multiple facilities.”
In practice, however, it is not so cut and dried. Domestic production is likely to remain concentrated because only a few players have economies of scale to maintain a large, continuous flow of production. Carrying out a buffer inventory of infant formula may be a responsible public health practice, but this contradicts what Shi called “good operating practice” saving production and inventory management.
In general, businesses that invest in sustainable operations face the challenge of pricing and shifting their cost increases. Companies that accumulate stocks, or that add production and distribution capabilities to ensure proper product availability, must cover the cost of transporting the goods. However, a consumer who compares goods on store shelves is interested in the selling price, not how much the company has spent on storing and distributing the product.
According to Shi, consumers may absorb the marginal cost of relatively small investments increased by a unit of production of large volumes, but with rising prices for almost all efforts to recoup significant investments in resilience will face consumer resistance. What’s more, investors don’t look at companies that tie up their capital to build up buffer stocks.
“It all depends on the price,” Shea said. “We’re in a race to the bottom.”
Jason Miller, a professor of logistics at Eli Broad College of Business at Michigan State University, said the shortage of foreign goods is the biggest obstacle to increasing sustainability in the baby formula supply chain. According to him, nothing can be done to change the large-scale savings in production or for distributors to continue to hold relatively limited stocks.
Since COVID-19 overturned the supply chain more than two years ago, there has been much debate about the need to abandon long-established production methods just in time in favor of more sustainable operations. The needle will be difficult to move. Expenditures on the addition of premises and equipment will be joined by the lack of storage space and various forms of labor. However, this remains a problem of high visibility both in boardrooms and in C-suites. This is especially true of Abbott, a 134-year-old company and one of the most respected brands in the world.
“I’m sure after that they’ll rethink how they do it,” Shea said.