Understanding How and Why Supply Chain Challenges Occur Can Help Mitigate Future Risks
The pandemic has disrupted supply chains on a global scale, resulting in challenges across industries as companies struggle to meet rising demand amid longer shipping times and rising input prices. Production challenges, inflationary pressures, and labor shortages have led to a series of complex hurdles that have generated negative outcomes for business owners and consumers alike. Understanding how and why these disruptions have occurred can help mitigate future supply chain risks.
Simply put, a “supply chain” is the network that a company uses to offer goods or services to customers. The term “tier” is used to describe one “step” along the path until the finished product reaches its destination. The pandemic demonstrated that dislocation within one tier can disrupt the entire supply chain. Tier lists must be examined on a granular level to fully uncover and address vulnerabilities within supply chains.
Supply Chain Tier List
Source: Capstone Research
Production Shutdown and Shifting Consumer Preferences Drive Backlogs
The pandemic has had a significant effect on supply chain backlogs in recent months. The root of this complex problem has been driven by a sudden and drastic shift in consumer spending habits paired with major factory shutdowns and production shortages. May 2020 marked the largest synchronized shutdown since World War II as the pandemic swept across the globe forcing businesses to pause operations. Industrial production ground to a halt as key exporting countries like China imposed mandates that shuttered factories. Meanwhile, government-imposed lockdowns resulted in a shift in consumer spending habits as people were forced to transform their homes into a combination of an office, gym, daycare, and restaurant. Product purchases like electronic devices and gym equipment were justified as the normal monthly expenses for commuting, travel, and entertainment were non-existent. As a result, the average consumer was spending a disproportionate amount on goods rather than services.
Pandemic lockdowns also forced many small businesses to expand their online presence. Online retail purchases in Q1 2021 accounted for 13.6% of total sales, representing a 39.1% year-over-year (YOY) increase, according to the U.S. Census Bureau.1 The increased demand for material goods along with the added volume of online purchases amid the pandemic put an incredible strain on supply chain networks, particularly for those that ran on outdated infrastructure, thin margins, and even thinner time constraints. Warehouses and fulfillment centers were overrun with orders and struggled to meet the “one-day free shipping” policy that has become industry standard.
Producers Fail to Meet Raw Materials Demand
Heightened consumer spending on material goods increased the demand for raw materials such as wood, steel, and silicone. On the other hand, global raw material production ground to a halt due to lockdowns and social distancing restrictions. Additionally, production has been slow to meet full capacity post-lockdown due to widespread labor shortages. Supply for raw goods is now severely lagging behind demand, and the ripple effect of these supply chain disruptions continues to proliferate.
Sharp price increases for raw materials have sent shockwaves throughout essentially every sector. Some of the most extreme price increases YOY include Corn (116%), Hides and Skins (146%), Natural Gas (132%), according to the Bureau of Labor Statistics.2
Case Study: Global Semiconductor Shortage
The increased integration of computer chips in everyday products has caused demand for semiconductors to skyrocket. Automobile manufacturers such as the Ford Motor Company (NYSE:F), General Motors Company (NYSE:GM), and Tesla (NasdaqGS:TSLA), whose new cars can have upwards of 1,000 computer chips, have announced they are scaling back on new car production due the scarcity of these advanced components. Additionally, a large fire at one of the world’s leading auto chip factories in Tokyo, Japan, has slashed supply for specialty chips for a multitude of industries. The company that owns the factory, a subsidiary of Renesas Electronics Corporation (TSE:6723), estimated revenue losses at the equivalent of $160 million a month, according to The Wall Street Journal.3 This supply and demand imbalance has only been exacerbated by labor issues and factory shutdowns during the pandemic. In September, consulting firm AlixPartners projected that the shortage will cost the global Automotive industry $210 billion in lost revenues—almost double the firm's May forecast of $110 billion.4
The global semiconductor shortage continues to expand beyond the Automotive industry, with the issue impacting everything from the price of printers to video game consoles. Internet of Things (IoT)-connected devices have been a more recently affected area in the wake of the shortage. “We expect supply constraints during the September quarter to be greater than what we experienced during the June quarter. The constraints will primarily impact iPhone and iPad," said Luca Maestri, Chief Financial Officer at Apple (Nasdaq:AAPL), in the company's fiscal Q3 2021 earnings call.5
Transportation Networks Crack Under Pressure
Shipping delays have stressed transportation networks with port congestions and bottlenecks extending fulfillment timelines across all industries. Notably, over 80% of all international trade is carried by container ships, which represents a more cost-effective means of transportation compared to air freight, according to the United Nations' Review of Maritime Transport.6 The pandemic has put significant strain on shipping companies and the supporting infrastructure including ports, cranes, and containers.
Before COVID-19, there was a steady flow of goods between exporting countries like China and importing countries like the U.S. As consumer demand waned at the onset of the pandemic, shipping routes were canceled, and empty shipping containers left in cargo ports and warehouses. The sudden and strong resurgence in demand for manufactured goods led to major backlogs and bottlenecks at manufacturing facilities and ports, ultimately resulting in shipping delays, container shortages, and overall port congestion. The market rate for shipping containers has subsequently climbed 406% YOY from $2,174 in mid-September 2020 to $10,996 as of September 18, 2021, according to Frieghtos Baltic Index.7
Finally, port congestion emerged as another supply chain headwind that contributed to further delays in final delivery of goods. The San Pedro Bay Port Complex that is made up of the Ports of Los Angeles and Long Beach handles 31% of all cargo coming in to the U.S. and has captured 74% of the West Coast's maritime shipping market share, according to the Port of Los Angeles fact sheet.7 This poses major concentration issues and during the height of the pandemic, ships could expect to wait in the outer Los Angeles harbor an average of five days to be unloaded, not only due to the increase in goods being delivered, but also due to the decrease in available skilled labor to offload cargo.
What to Expect and How to Prepare
Founders and entrepreneurs continue to combat dynamic supply chain challenges as the full effect of this multifaceted issue is still unfolding. However, as COVID-19 related restrictions have eased, it is expected that consumers will return to a more balanced spending distribution between goods and services, resulting in less strain on manufacturing and transportation networks. The one certainty we know today is that the pandemic exposed many cracks in global supply chains and may continue to result in prolonged delays and the loss of potential cost benefits of a more efficient fulfillment network.
Firms that fortified supply chains from adverse governmental regulations and economic disruptions prior to the pandemic have been able to reengage in growth initiatives. To ensure that U.S. businesses mitigate these issues going forward, an increased focus on supply chain visibility and diversification is necessary. Building a network of multiple material providers and manufactures based in different countries will help provide a constant flow of supply. Better yet, manufacturing in the U.S. is increasingly attractive due to time and cost savings on shipping. Additionally, increased investment in logistics tools like real-time transportation visibility platforms (RTTVPs) can provide a greater sense of security for business owners and spot potential supply chain issues before they manifest into a disruption of operations. In the case of supply chains, a strong defense is the best offense.
Ways to Improve Supply Chain Defensibility
Source: Capstone Research
The pandemic forced many businesses to look inward and examine their production vulnerabilities and conduct stress tests to gauge their level of supply chain and revenue defensibility. For instance, the Just-In-Time manufacturing method, widely adopted to promote agility, instead exacerbated product shortages and showcased the importance of overall inventory management.
While many businesses halted inorganic growth initiatives during COVID-19, they are now actively searching for ways to safeguard and diversify their assets and supply chain, with mergers and acquisitions (M&A) serving as a valuable option. In the current valuation environment, strategic buyers have demonstrated a willingness to pay premium purchase multiples for accretive businesses that enhance production processes, product offerings, and drive synergies and margin improvements. Our team of M&A industry experts are available to discuss how to ascertain the fair value of your business, monetize your assets, or pursue a full liquidity event. In addition, our Financial Advisory Services Group which leverages a wealth of Big 4 Accounting Firm experience, is able to take an in depth look at your financials and provide solutions to improve operating performance. To learn more or to speak to one of our experts on your industry, please contact us.
U.S. Census Bureau, “Quarterly Retail E-Commerce Sales 1st Quarter 2021,” https://www.census.gov/retail/mrts/www/data/pdf/ec_current.pdf, accessed August 15, 2021.
S. Bureau of Labor Statistics, "Producer Price Indexes," https://www.bls.gov/news.release/pdf/ppi.pdf, accessed September 21, 2021.
The Wall Street Journal, “Fire at Giant Auto-Chip Plant Fuels Supply Concerns,” https://www.wsj.com/articles/renesas-chip-plant-fire-spreads-concerns-about-global-auto-production-11616414181, accessed September 5, 2021.
AlixPartners, "Shortages Related To Semiconductors To Cost the Auto Industry…," https://www.alixpartners.com/media-center/press-releases/press-release-shortages-related-to-semiconductors-to-cost-the-auto-industry-210-billion-in-revenues-this-year-says-new-alixpartners-forecast/, September 30, 2021.
The Motley Fool, "Apple (AAPL) Q3 2021 Earnings Call Transcript," https://www.fool.com/earnings/call-transcripts/2021/07/28/apple-aapl-q3-2021-earnings-call-transcript/, accessed September 5, 2021.
UNCTAD, “United Nations Review of maritime transport,” https://unctad.org/topic/transport-and-trade-logistics/review-of-maritime-transport, accessed August 2, 2021.
Freightos Baltic Index, "Freightos Baltic Index (FBX): Global Container Freight Index," https://fbx.freightos.com/, accessed September 21, 2021.
Port of Los Angeles, “Facts and Figures,” https://www.portoflosangeles.org/business/statistics/facts-and-figures, accessed July 27, 2021.
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