Supply Chain Crisis

by Thomas Bauer

Amid the recovery from the Covid-19 pandemic, the global economy was hit with yet another major setback:  a supply chain crisis.  Global supply chains have been under extreme pressure recently, with several major transportation and logistics companies reporting backlogs at ports of entry and lost cargo.   These delays have been caused by several factors:  worker shortages, surging demand, low safety stocks, and high commodity volatility.

The United States is currently experiencing the worst worker shortage in decades.  The recent jobs report from the Bureau of Labor Statistics stated that the economy added 315,000 jobs in August. Wages continue to rise, albeit at a slower pace than overall inflation. The job market is still very strong and demand for workers outpaces supply. At the end of June, there were still nearly twice as many jobs openings as unemployed workers.  This worker shortage has hit the transportation industry particularly hard, resulting in an estimated 80,000 unfilled semi-truck driver positions in 2021.  This shortage has made it difficult for shipping companies to bring goods to and from ports to stores, resulting in further congestions at ports and ultimately, goods left to sit on container ships.

As the economy emerged from the Covid-19 pandemic, consumers found themselves with higher disposable incomes than they had seen since 2019.  This was driven by more people returning to work, as well as stimulus checks, leaving people with extra cash.  Further, with inflation being high, 8.5% annually as of the end of July, consumers have little incentive to save this money, as its purchasing power dwindles, with long term interest rates well below inflation.  This has caused demand for many goods to rise beyond what analysts had forecasted, resulting in shortages of goods.  This supply chain crisis has been particularly hard felt by consumers, due to the popularity of lean and just-in-time (JIT) operation strategies.  In an effort to cut costs in an increasingly competitive global economy, many companies have adopted operational and manufacturing strategies that involve holding minimal inventory, allowing for a more efficient use of capital.  However, this has resulted in a decrease in the safety stock held in warehouses across the country.  When shipments from ports became delayed, companies had no extra inventory they could draw on to sell to consumers. As such, shelves in stores across the country are left unstocked.

The war in Ukraine has also had an adverse effect on the health of global supply chains through rising prices of commodity items.  When Russia invaded Ukraine in March 2022, western power placed harsh sanctions aimed to punish Russia for its military actions. These sanctions prevented the importation of many key goods from Russia.  Russia and Ukraine are major producers and exporters of wheat, corn, and oil.  The disruptions of global commodities have led to sharp increases in both future and spot prices, which has in turn increased the price of consumer goods derived from these commodities, like food and gasoline.

These supply chain issues have affected nearly every industry, but certain industries have been hit harder than others.  For example, the automotive manufacturing industry, an industry known for its use of lean and JIT manufacturing, has seen rising prices and shortages of important components.  Automotive manufacturers were forced to cut unit production in 2020 and 2021 after sourcing departments were unable to acquire semi-conductor chips for their vehicles.  Semi-conductor chips, also known as microchips, are used in almost every electronically controlled system in modern vehicles, like cruise control, airbags, and lights.  As a result, there is a massive shortage of new and used vehicles on the market.  This has caused the average used car price to increase 36.9% between January 2021 and January 2022.

Another good that has been uniquely affected by these issues is baby formula.  Demand for the product outpaced analysts’ expectations, leaving grocery store shelves bare and parents unsure where they can find this essential product.  Manufacturers have struggled to increase production, as their efforts have been met with difficulty in obtaining ingredients and packaging materials, as well as securing transportation to warehouses and store shelves.

In the short-term, companies may see lower revenues and higher transportations costs as they struggle to source their raw materials and get finished products to shelves.  In the long-term, companies may move away from lean and JIT operations by maintaining higher levels of inventory to avoid future supply chain issues. An industry-wide increase in inventory would increase the level of working capital companies maintain.  Since working capital typically provides a lower return to shareholders than alternative uses of capital, we may see lower overall returns for companies.  While a lower level of returns could lower company valuations, the lower level of risk associated with profits may offset this impact. The result may be companies that have less risky, less efficient operations as a way to mitigate supply chain risk.