Exploring the reasons for supply chain breakages in the US and looking into possible solutions.
Author: Mallika Verma, Dark Byte Capital
US Supply Chain
The COVID-19 pandemic spread a wave of supply and demand shocks all over the world. It has been difficult for companies and governments to decide what production to prioritize and how to meet the overarching global demand. From toilet paper to basic consumer discretionary products, every supply chain was tested and continues to be strained as the world emerges out of this crisis.
What is supply chain?
A supply chain is a network between a company and its suppliers to produce and distribute a specific product to the final buyer. This network includes different activities, people, entities, information, and resources. The supply chain also represents the steps it takes to get the product or service from its original state to the customer.
US Supply Chain — Current Situation:
- The Institute for Supply Management’s April survey of purchasing managers across the US showed a backlog of orders that was the highest on records that date back to 1993. The average lead time for sourcing production materials increased in April by four days to a total of 79 days — the highest since ISM began collecting this data in 1987.
- McKinsey Global Institute research from August 2020 shows that, due to supply-chain issues, companies can expect a production line stop that is greater than one month approximately every 3.5 years.
- Global logistics company CH Robinson said ships at West Coast ports in the US are waiting between 15 to 20 days to berth, compared with no waiting period in a normal market. For every truck there are more than seven loads of freight to be carried, compared with three in more normal times.
- US and China trade tensions are rising by the day. China is exploring the possibility of limiting the export of rare earth minerals that are crucial for the manufacturing of American F-35 fighter jets and other sophisticated weaponry. This poses a major threat to the US defense industry. This is just one of the examples of the risks trade tensions can pose.
Problems resulting from Supply Chain Disruptions:
- Companies increase prices of their goods and products as they pass on the cost of higher raw material to the consumers. Few examples of companies that have already done this are Colgate-Palmolive, Kimberly-Clark, Mondelez and Whirlpool.
- When the cost of goods increases, inflation rises which in turn brings down investor confidence and the government often has to step in to regulate financial markets.
- Increasing prices make it even more difficult for minorities and poorer communities to afford day-to-day necessities as it widens the wealth gap between the rich and the poor. The rich are able to afford even as prices rise but the poor often feel the burn the most.
- If costs continue to rise in the coming months, it will be become harder for companies to be able to maintain existing high profit margins.
Recent examples of supply chain disruptions:
Current Situation: Lumber prices rose more than 240% from its average price in 2020, which was the previous lumber price record. The great lumber squeeze has added thousands to new home prices. The National Association of Homebuilders (NAHB) estimates the price rise adds US$24,386 to the cost of a single-family home.
Reason: 1) High demand for housing 2) High demand for home improvement and remodelling 3) Lower pre-pandemic demand 4) Increased import duties on Lumber imports from Canada.
Future Outlook: As interest rates rise and affordability becomes a concern for households, the demand for new houses will decrease and lead to a slump in lumber prices.
Current Situation: The entire world is currently dealing with a shortage of semiconductors as demand to digitalize everything increases. At the moment, the vast majority of chips used in US and Europe are manufactured in Asia. The rising trade tension between US and China is calling for greater self-reliance. Chip shortages have also encouraged hoarding which is widening the gap between demand and stagnant supply. According to Goldman Sachs, 169 industries have been affected by the semiconductor shortage and the worst-case scenario would be a 1% reduction in the US GDP.
Reason: 1) Shift to work from home economy and digitalization of most industries 2) High demand from the automobile industry as people move to suburban residential areas 3) Lower number of supply orders were placed in the beginning of the pandemic which led to a supply shortage in the middle of the pandemic
Future Outlook: The demand for semiconductors far outweighs the current supply levels. The demand is only expected to rise as developments in cryptocurrencies and cloud computing picks up.
Intel is investing $20B in U.S. to build two factories in Arizona to ensure a secure and consistent semiconductor supply to US and other parts of the world. The company also hopes to start producing chips, within six to nine months — to address shortages at American car plants.
- Risk Management using Data: Companies are starting to use data and artificial intelligence to identify potential risks early on. One such example is that of Metinvest, a group of 30 Europe-based steel and mining companies that have come together to share data. The information they share includes — inventory levels and production capacity. They perform critical assessments to identify anomalies and data patterns to uncover any underlying issues.
- Collaborating with various suppliers: It is important for companies to maintain relations with various suppliers so they can diversify their sources. The pandemic forced companies to rethink their supply chains and companies were seen moving their manufacturing facilities outside China.
The government under the Biden administration has been very proactive in reviewing and tackling supply chain issues. They have been conducting risk assessments on 4 sectors, namely, semiconductor, high-capacity battery, strategic materials (rare earth elements), and pharmaceuticals.
Apart from the above, the government will be mandating a 12-month comprehensive review and risk assessment of the industrial bases relevant to seven federal departments (Agriculture, Commerce, Defense, Energy, Health and Human Services, Homeland Security, and Transportation).
This is definitely a tedious task considering that on an average, a large company has more than 5,000 suppliers that need to be discovered and assessed.
Future of Supply Chain
Supply chain shortages usually result from deeper underlying problems. It is important to identify and assess those issues. This not only takes a lot of time but often also requires some fundamental changes in the way industries operate.
High Demand: Industries like travel and tourism, retail and consumer discretionary are likely to experience an increase in demand when the economy re-opens. Most of these industries depend on China and other Asian countries for their raw materials. It will be important to note how the Biden administration works with the Chinese government to ease trade tensions. If the trade tensions get worse in the next few years that could pose a significant problem for the North American markets.
Supply Chains to watch for: Lithium-powered batteries and plastics are the industries that could next face some supply chain issues. The demand for lithium-powered batteries is increasing in US as more and more companies venture into the electric vehicle space. Strong worldwide demand for plastics and low levels of supply due to worst hurricane season in years in the Gulf of Mexico and the American Gulf Coast and Louisiana.
Vertically integrated companies have been able to fare better than others during the pandemic. It is important for investors to study the company’s supply chain management before investing. It is particularly important to note how big of a risk does a company’s supply chain pose for its products and what the management does to hedge that risk. With demand levels rising globally, supply chain management remains a top priority for companies and governments.
If investors are able to identify these problems before-hand they might be able to predict the movement in the market to some degree, thereby winning short term investment opportunities.