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Global Supply Chains – “Winter is Coming”

• The recent China COVID-19 lockdowns have created a massive logjam at the Port of Shanghai and a global supply chain quagmire with significant operational and inflationary knock-on effects.

• Supply chains, which have become more complex and more integrated over time, may soon undergo significant changes as companies assess changing geopolitical dynamics with availability and rising costs of goods.

• As they evaluate supply chain cost vs control trade-offs, companies may begin to favor more control to maintain competitive position albeit with potentially significant profitability and valuation impacts.

20220510-chartSupply Chain Evolution and Innovations

Supply chains make the global lifestyle possible, yet many of us think very little about this modern industrial miracle – the process of orchestrating the sourcing, manufacturing, shipping and delivering goods to the end customers.

Modern global supply chains are the result of a number of innovations dating back to the standardization of the 20ft intermodal shipping container in the 1950s. Since then, specialized container ships have grown to haul upwards of 20,000 containers, real-time inventory management systems now track the location and status of every item on board, intermodal trains and trucks seamlessly dock with shipping ports, and automated systems facilitate the loading and unloading of ships, trains and trucks.

Regulatory innovation, namely the General Agreement on Tariffs and Trade in 1947 (GATT), along with economic liberalization in China, India and other Far East markets along with the establishment of the European Economic Union, drove demand for trade post-WWII and accelerated supply chain innovation.

In short, a consistent international regulatory and trade environment coupled with reliable, low-cost transport enabled companies to source goods from suppliers worldwide, enhance just in time (JIT) inventory management capabilities, enhance their product offerings and provide lower product costs and/or higher quality to end customers.

Supply Chain Quagmire

Over time, supply chains became more complex and more integrated, the benefits of which were consistently lower product and transportation costs, predictable schedules and ample supply. Although they were ceding significant control, companies could often dramatically lower overall costs in sourcing goods. However, as we are now experiencing worldwide, the disadvantage of outsourcing significant operations is a lack of control and potential for massive operational disruptions.

Front and center is the Port of Shanghai, the largest container port in the world which processes over 43 million Twenty Equipment Units (TEUs) annually.1 The most recent China COVID-19 lockdowns have dramatically impacted port operations to approximately 10% of normal activity2, and as of April 19, 2022, over 500 ships (an estimated 3-5 million TEUs) were waiting to deliver goods to China.3

Other large ports (Long Beach and Los Angeles, for example) have also experienced increased delays from a shortage of dockworkers, truckers and warehouse storage, along with knock-on effects from other port logjams.4

“Winter is Coming”

In the near term, it is unlikely that the current global supply chain issues and supply shortages will subside. A backup in a supply chain is similar to water behind a dam - when the water is quickly released, the land area downstream gets flooded. Moreover, these shortages are creating significant inflationary pressure as the prices of available input goods are bid up by producers, which in turn are absorbed into the margin of finished products.

Once operations normalize in Shanghai and other large ports, expect additional operational knock-on effects for many months as the volume of additional goods ripples through air, rail, truck, warehouse and other logistics channels.

Longer term, the impacts from protectionist trade policies, the ongoing Ukraine conflict and other geopolitical dynamics are unlikely to dissipate anytime soon, providing a catalyst for companies to rethink the calculus of cost vs control of their supply chains and how they can position for a changing global environment, perhaps transitioning from JIT to JIC (just in case) inventory management.

As they evaluate these trade-offs, companies may begin to favor more supply chain control to remain competitive. These efforts could include: vertical integration, adding local production capacity, sourcing inputs from less distant locations (near sourcing), increasing inventory and warehouse capacity and increasing direct logistics capabilities. These challenges could also create opportunities for both existing vendors and new entrants to emerge with capabilities to manage and facilitate the restructuring of global supply chains.

Post COVID-19, the wheels appear to be in motion for significant changes in how companies manage global supply chains as “winter” may well be coming. Companies that pursue changes may face higher costs and potentially lower margins, but in a competitive global economy, these changes may be essential to maintain market position. From a macro perspective, overall costs would likely increase, which may only create additional inflationary pressure to an already fragile global economy.

Important Disclosures & Definitions

Performance data quoted represents past performance. Past performance is no guarantee of future results; current performance may be higher or lower than performance quoted.

1 Statista, as of 2021

2 Fortune, as of April 19, 2022

3 The Maritime Executive, as of April 19, 2022

4 Bloomberg News, as of April 7, 2022

General Agreement on Tariffs and Trade (GATT): a trade agreement intended to boost economic recovery after World War II through reconstructing and liberalizing global trade. Signed on October 30, 1947, by 23 countries, GATT was a legal agreement minimizing barriers to international trade by eliminating or reducing quotas, tariffs and subsidies while preserving significant regulations.

Intermodal: containerized products and raw materials that are transported by a variety of modes such as shipping, road and rail.

Knock-on Effects: secondary or cumulative effects from another event or circumstance.

Twenty Equipment Unit (TEU): a shipping container whose internal dimensions measure 20 feet long, 8 feet wide and 8 feet tall.

ALPS Advisors, Inc. is affiliated with ALPS Portfolio Solutions Distributor, Inc.

ALPS Portfolio Solutions Distributor, Inc., FINRA Member.

APS001981 05/31/2023

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