I am going to start with an obvious statement:
The COVID-19 pandemic had – and is continuing to have – an unprecedented impact on production and supply chains globally. Very few industries have been spared disruption. If you look at our own portfolio of clients, the magnitude of declines has been anywhere from 10 to 50 percent depending on the industry profile. According to reports from Dun & Bradstreet, virtually none of the Fortune 1000 had no disruption.
Overall, nearly three-quarters of U.S. companies have faced some sort of supply chain disruption in the last 90 days. If we look at some data, if you think about the impact of global trade, a fair-case scenario would have global trade dropping back to levels of 2010, which would be a 40-percent decline. We are looking at foreign trade expected to drop by a third potentially this year; 70 percent of U.S. ports have restricted travel of some sort.
The biggest challenge is not just managing the magnitude of the decline, but preparing for what happens going forward?
From a production standpoint, one of the biggest impacts is the slow down in deliveries and the impact that manufacturers have had managing new safety measures, social distancing, having to shut down, having to restart. Right now we’ve seen durable goods orders drop about 30 percent. If you’re looking at Chinese manufacturers, some are still only operating at 60-percent capacity.
In relation to inventory-to-sales ratio over the past decade, we’re at relatively unprecedented levels of inventory as a percentage of sales. The vast majority of companies have expected to increase inventory and run with higher levels to manage disruption and potential disruptions to their suppliers. All of this has a tangible economic cost. Liquidity has also become even more important as corporates are solidifying their balance sheets and are becoming more concerned about the financial health of their suppliers and inventory disruption risks that may come from supplier liquidity risks.
If you think about it from a cargo shipping standpoint, a substantial input cost, one of the biggest problems is capacity has been offline. Volumes are down 10 percent, but you’re also seeing capacity drop. Air capacity is also off by a third. The result: higher rates.
So during a period where you’re seeing depressed demand, you’re actually seeing shipping rates go up, which is putting quite a squeeze and a cost headwind for everybody.
Shifts in Geographies
If we were to take a high-level view of the macro backdrop and some of the most important themes, I think the first would be how to think about decentralization or reducing concentration-ranked risk and diversification within supply chains.
Eighty-two percent of US firms surveyed said they were looking to bring some level of production back to the US. Seventy-five percent of CFOs are reinforcing their goal to diversify some of their production out of China.
The question then becomes: is this a short-term reaction to the pandemic, or will it lead to a real level of disruption to Chinese exports?
Which leads to another question: where will the production land?
I think the first potential beneficiary would be the United States, certainly in the pharmaceutical and medical-supply space, but that could broaden out to a lot of other industries. We’ve started to see some movement on moving semiconductor manufacturing back to the US. Intel announced a facility they’re going to be building in Arizona and I think we may see more of that. Mexico and China are two big areas of manufacturing capacity for the automotive sector, though we see some of that repatriated back to the U.S., which still has lots of capacity.
New Inventory Model
As far as inventory, e-commerce (and retail overall) has been driven by the just-in-time concept of inventory. The themes there are efficiency, cost reduction, and real-time matching of supply and demand. COVID is exposing the fragility of this model. Just-in-time is really good at containing costs. It’s not good at building redundancy and it’s not necessarily good at tail risk disruption. So an alternative that’s being talked about is just-in-case inventory. Just-in-case is building up redundancies and carrying more inventory. The strategy is really aimed at managing through major disruptions.
There are certainly going to be strategic reasons for industries that provide critical goods and services to think about a just in case model, but it comes with trade-offs. With redundancy comes higher carrying, storage, and labor costs. So there’s unintended consequences of that, but, for medical, pharmaceutical, cleaning supplies, and certain areas within food, just-in-case may become more popular over time.
With a just-in-case model, there is more liquidity tied up in inventory, which leads to more pressure to forecast accurately. Moving and distributing your supply across a broader range of suppliers means more relationships to manage. And so really what this is about is being less reactionary, being a little bit more stable, but at the expense of potential liquidity.
Obviously, COVID has changed (and continues to change) how companies manage their production, supply chains, and inventory. While there are a number of questions that aren’t completely answered, there is no doubt that many of the impacts will be long lasting and represent a seismic shift. At LSQ, we are committed to helping companies like yours navigate the future of supply chains (and finance). Stay tuned to our blog for the last insights or contact us to learn how our solutions can help keep your supply chain healthy and resilient.
To learn more about steps you can take to minimize disruption to your supply chain, view our latest webinar.