Advisors - November 11, 2021
5 Weak Links of the Broken Global Supply Chain
Empty shelves, higher prices, longer shipping times, and even weeks-early Black Friday deals have thrown the relationship between consumers and producers into limbo. The often-cited reason? A global supply chain in crisis.
The definition of supply chain is “the sequence of processes involved in the production and distribution of a commodity.” Each party involved in the global supply chain—suppliers, manufacturers, distributors, retailers, and end consumers—have been affected down or upstream by issues another group is facing.
You’ve heard the supply chain is broken, and you see it anecdotally through higher prices and bare shelves, but which parts of the sequence are actually causing the problems you’re facing? We’ll dive into five weak links of the global supply chain, the effects of each, and explore industries most-affected by the worldwide crisis.
1. Retail Sales Rebound Too Much, Too Fast
US Retail Sales have risen steadily since the financial crisis bottom in 2009. US Retail Trade Inventories rose steadily as well, but it was retail sales that experienced a major whiplash in 2020. First, a plummet at the onset of the COVID-19 pandemic, followed by an even sharper rebound just two months later. While that might sound like good news on the surface, the snapback would lead to the first broken link in the supply chain: strained inventories. The Retail Trade Inventory-to-Sales Ratio sunk to where just 10% of additional inventory is on hand for every sale, compared to the typical 50% cushion.
Strong consumer demand is also reflected in US Personal Spending. Like retail sales, personal spending rose at a steady rate since 2010, plummeted in spring 2020, and ultimately snapped back at an even higher rate of growth. Consumers are making it clear they have more money than ever before and want to spend it. But, as we’ll explain next, the unprecedented consumer rebound threw a major wrench into suppliers’ production plans.
2. Producers Scramble to Meet Consumer Demand
Consumers can adjust their spending habits much quicker than producers can tweak their production schedules. This can ruin producers’ carefully-constructed forecasts if consumers decide to buy more or less. To meet the growing consumer demand, producers have had to source raw inputs hand-over-fist, leading to a higher US Producer Price Index. In fact, unassuming materials have made headlines because of their eye-popping price increases, including Lumber & Wood Products, Dairy, and metals such as Copper.
The scramble by manufacturers isn’t happening just within US borders. China, as a large net exporter, produces both goods used by foreign manufacturers and final products for consumers. China has been unable to keep up with growing global demand for its exports, as evidenced by the country’s declining Supplier Delivery Time Index. (a lower number means longer, less reliable delivery times)
As a direct effect, US manufacturers have been forced to extend their lead times for the production of final goods. According to the Richmond Fed, manufacturing vendor lead times have surged 8x its historical average to an all-time high.
3. Shipping Costs Explode for Distributors
With more goods being produced, another pandemic-hobbled industry has been caught off guard by rising demand: shipping. As an example, costs for an 8500 twenty-foot equivalent vessel—a larger ship that can ferry 8,500 standard-size shipping containers—have increased nearly five-fold. Capital and consumer goods shipments, which are raw goods and end products, respectively, have rebounded to their pre-pandemic levels. That’s something the shipping industry didn’t expect after months of inactivity and closed ports.
While the boom in sales is good news for the retail industry, the SPDR S&P Retail ETF (XRT) has traded sideways since the surge in shipping rates. One possible reason: retailers are struggling to protect their bottom lines from exploding shipping costs.
4. Labor Shortage Slows Entire Supply Chain
The unemployment rate is back below 5%, which many might consider a sign of a healthy job market. However, the labor force participation rate has been relatively flat since mid-2020 and has been unable to eclipse pre-pandemic levels. The worker shortage comes despite a record number of job openings, as the recent “Great Resignation” movement has fueled the desire among employees to search for more flexible and fulfilling employment opportunities.
Nonetheless, workers are essential across the entire supply chain, especially during periods of heightened consumer demand. During a labor shortage, critical areas of the global supply chain such as the manufacturing, transportation, and distribution of goods can be severely disrupted.
5. Consumers Become Their Own Worst Enemy
Finally, labor and material shortages combined with high consumer strength have led to inflation as costs are passed down to the price tags we all balk at. One and three-year ahead inflation expectations show price growth isn’t expected to slow down anytime soon. If consumers continue to spend at these levels, and employers continue to pay higher wages to fill openings, higher prices could be here to stay.
Furthermore, if prices get too high, consumers could slow their spending. This can thwart manufacturers’ production schedules, but to their disadvantage as a weakened consumer typically results in fewer orders. It’s at this final, consumer-induced stage that supply chain woes come full circle.
Industries Affected by the Broken Supply Chain
Worldwide semiconductor sales have soared to all-time highs, but the production of semiconductors in the US has stalled for the last four months. Semis are an essential component of many products these days, from smartphones and automobiles to the clock on your kitchen stove. Will manufacturers answer the global chip shortage by ramping up semiconductor production? Or will they maintain current prices and output levels, opting to ride the wave of strong consumer demand?
Following a V-shaped recovery, car sales are plummeting once again. As a major consumer of semiconductors, the chip shortage has largely led to a growing cost of manufacturing cars as well as less cars produced. With average prices of both new and used cars reaching all-time highs, the red-hot consumer was quick to put plans for a new car on ice after the initial recovery in vehicle sales.
Both new and existing home prices are at all-time highs, which is good news for homeowners. However, prospective buyers are at a disadvantage, having to pay higher prices than ever before. The price of lumber, metals and other building materials is partly to blame, as both the construction of new homes and improvements to existing ones become more expensive. Regardless, both new and existing home sales have cooled off in recent months, suggesting buyers are less willing to purchase a place to call home right now.
How Do You Mend A Broken Supply Chain?
The supply chain crisis has had worldwide impact, from longer production times and material shortages to higher consumer prices and delayed shipments. Only when the equilibrium between each link is improved can the supply chain be fully repaired.
Suppliers could increase capital expenditures to purchase more production equipment and source more raw materials to keep up with consumer demand. Sellers could also pass more costs along to the end consumer, thereby pricing out enough buyers and reverting prices as well as inventories back to the mean. No matter what actions are taken, all parties involved should be aligned on a common goal: a return to stability, certainty, and balance within the global supply chain.
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