A sensible response to rising costs

It's amazing how quickly everything you take for granted can change. A currency fluctuation here, a commodity shortage there, and what has long seemed a perfectly sound approach to business suddenly makes no sense at all.

Consider this. It takes roughly nine tons of bauxite to make one ton of aluminum. Much of the world's bauxite comes from South America, but the largest producers of aluminum are in Asia. For years, Latin American mining companies have been extracting bauxite from the earth, loading it onto ships, and sending it to Asia, where it's made into aluminum. Most of the finished aluminum is then shipped to North America and Europe.

This all made good business sense until something changed: the cost of oil. Skyrocketing oil prices translated to sky-high shipping costs. And suddenly, the whole economic justification for shipping ore around the planet so it could be processed in a lowcost country was called into question.

Although the price per barrel of crude oil has dropped from its July 2008 high of US $147 to just under US $45 as this issue went to press, no one expects that it will stay there. Prices could remain volatile for weeks, months, even years to come.

Add in factors like currency fluctuations and rising wages overseas, and it's easy to see why volatility is causing many to reconsider the way they manage global supply chains. As 2009 unfolds, more companies may choose to shift production from Asia to locations that are closer to home. And it would be no surprise to see companies that operate a few large, centralized distribution centers abandoning that model in favor of more, smaller facilities located closer to customers—thus reducing their reliance on increasingly expensive longhaul transportation.

Here's one example of how fuel costs have changed over the years. According to the economic research firm IHS Global Insight, in 1999 a fully loaded tractor- trailer could drive 3,009 miles on US $500 worth of diesel fuel. By 2004, the same vehicle could travel just 1,840 miles for that same amount of money. Today, that truck can only cover about 740 miles for US $500.

Which brings us back to bauxite, aluminum, and global supply chains. Suppose some aluminum manufacturers relocated their plants from Asia to Latin America. With that single stroke, they would eliminate the expense of shipping nine tons of bauxite from Latin America to Asia as well as the cost of moving the finished product—one ton of aluminum—back to markets in the Americas. Imagine how much the price of aluminum could be reduced—and the revenue of aluminum manufacturers enhanced—if those producers could avoid the costs of shipping both the raw material and the finished product around the world.

In today's economic environment, it would make perfect sense.