The spiral of supply chain bottlenecks

The pandemic-induced supply-chain shock is leaving us with a lot more economic pain than initially anticipated. The question now is: how long will it last? 

The pandemic created complex supply chain bottlenecks, exacerbated by booming demand, which led prices to soar around the world. Consumers are finally reacting, which could restrain spending. 

Panic hoarding

At the beginning of the pandemic, consumers rushed to store essentials, emptying shelves in supermarkets. It was a decision based on fear of not being able to buy goods. With time however, shelves gradually returned to normal. Today, the issue has shifted to supply chain concerns. In other words, firms in some cases build inventory, seeking “safety” stock to meet demand.

Shipping costs, which have surged since the pandemic, need to meaningfully come down to indicate the race to stock key components is ending. There are signs that businesses are desperately searching for materials across the board from key tech components such as “chips” to construction materials, to ensure they have the necessary supplies to satisfy orders. On one side, it is unclear if booming business for suppliers is based on hard orders or just inventory stacking. On the other hand, a drive to Ikea would suggest consumer demand is extremely strong as many items are unavailable. As a matter of fact, in response to logistics issues, Ikea along with other major retailers such as Walmart, Home Depot, and Target, are charting cargo ships on their own to alleviate supply chains burdens of bringing products from overseas factories.

Surging demand

People stayed home and as a result, savings accumulated over months during lockdowns. The return of the consumer came in the form of revenge spending, creating a high demand for certain discretionary goods. Surging demand sustained a restocking cycle and has put stress on supply chains that faced Covid disruption in East Asia and shipping delays. To illustrate the scale of the matter, the transit time for a container from Shanghai to California was 71 days before the pandemic; now it is 117 days.

Construction material such as Timber is also in high demand because of a housing boom in the US, thanks to low interest rates that make it easy to refinance mortgages to renovate or making housing more accessible to first-time buyers. In the auto industry particularly, automakers have been forced to stop taking orders as they are not able to fulfill them. For example, in early December, Tesla said it would not take Model S and Model X orders outside North America, and it expects those to restart in the second half of 2022. Similarly, Ford said it won’t be accepting new Maverick Hybrid orders until summer 2022.

Challenges in boosting supply 

As consumers took a hard look at their finances during the pandemic, so did businesses. Businesses have found it incredibly difficult to forecast demand, due to back and forth Covid waves. In some cases, supply chains were interrupted during lockdowns, creating more backlogs for businesses still attempting to ramp up production.

In turn, the government’s stay-at-home incentives led to sourcing challenges. With incentives misaligned and work interruptions, workers are hesitant to return to their old jobs, retired early, opted for alternative careers, or simply demand more benefits. These are causing long delays at US ports with container ships having to wait to unload their merchandise. While we can imagine that in some cases order backlogs will be fixed, in other cases groups of workers will probably permanently not go back.

Demand destruction

While profit margins for large businesses in the US are at a record high, smaller businesses struggle as they find it harder to absorb costs due to higher costs caused by supply chains frictions.
In other instances, demand for certain products have changed, in part due to a demand-destruction effect from supply chain disruption. For example, in the third quarter of 2021, Volkswagen made 35% fewer cars in comparison to the third quarter of 2020, and lower car production means less demand for other inputs, impacting sales of suppliers.

Amongst other things to consider, soaring energy costs could also cause a drag on consumer appetite to go back to pre-pandemic habits. For example, given the choice between ICE vehicles or EVs, many now chose EVs or hybrids.

In terms of shipping, the waiting time to receive orders may also be causing demand destruction. In early December, the number of ships waiting outside L.A. and Long Beach hit an all-time high of 96.

Container price remains elevated.

The Drewry World Container Index remains 168% higher than a year ago. The Index represents container freight rates on major routes to/from the US, Europe, and Asia, used as a benchmark for 40-foot ocean container prices.

Time

Moreover, according to Oden’s 2021 State of Manufacturing report the crisis has spurred more than half of manufacturers to make significant changes across their supply-chains. Industries like autos have started to re-shore or ‘nearshore’, scaling down production to be closer to customers, but even those efforts come with challenges. Additionally, suppliers are responding by opening new manufacturing plants in the West, but these could take years. In March 2021, Intel announced it intended to spend $20 billion on 2 manufacturing plants in the US. Intel CEO, Patrick Gelsinger believe that the chip shortage could last an additional 2 years. Other giant chip producers such as Samsung and TSMC have also said to be looking to open plants in the US. The challenge will continue to ramp up production fast to meet the booming chip demand.

Conclusion

Some suggest that the supply-chain crisis could last until 2023, but most likely things will improve by the middle of 2022. Ensnaring goods from around the world will surely remain a pressing issue in the coming months as we navigate between Covid waves and the effects of the Omicron variant. Structural changes are happening with businesses increasingly pulled towards sourcing locally and manufacturing domestically or nearby. While manufacturing plants and port operations will not be scaled up overnight, businesses have shown resilience in adapting to the pandemic. Thanks to vaccines, production is being halted much less frequently. Anecdotally, companies seem to think the worst is behind them, but it will most likely take months for a significant improvement to be felt.

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