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2021 Outlook: Life (during) after COVID-19 – supply chain strategies

Cons. Discr. - Apparel 404 Cons. Discr. - Autos 1012 Cons. Discr. - Durables 390 Cons. Discr. - Retailing 357 Global 1250 Health Care 291 Industrials - Capital Goods 506 Info Tech - Comms Equip 179 Info Tech - Tech Hardware 660 Outlook 81

Corporate supply chains have faced four years of upheaval as a result of shifting global trade policies and more recently the challenges posed by the COVID-19 pandemic. This report considers some of the key drivers for corporate decision making in 2021 and actions taken by companies so far.

The four (five) stages of COVID-19

Stage 1 Supply chain disruptions, starting in Asia

The SARS-COV-2 virus was first identified in late 2019, and progressed rapidly within Asia during Q1’20. The first effects on the global supply chain were felt in late January, with lockdowns in China shutting down manufacturing production. This was likely somewhat mitigated by the lunar new year holidays that commenced shortly after the lockdown started, but struggled to restart afterwards. Panjiva research of Feb 11 noted that Huida Manufacturing (Huzhou) had declared force majeure, foreshadowing some of the supply chain disruptions to come in the automotive sector. By Q2’20 automotive imports to the U.S. had fallen by 50.0% year over year.

Stage 2 Widespread demand destruction, partly offset by stimulus

The general spread of lockdowns – first in China, and then across much of the rest of the world by March – met manufacturing troubles with a slowdown in consumer spending, job losses, and economic uncertainty. From February to April, the U.S. unemployment rate rose by 320.0% year over year, and the economy plunged into recession driving a slump in international trade activity. 

Stage 3 Uneven recovery, still underway

As lockdowns lifted, companies started to bring their operations back online. This was complicated by continued economic uncertainty, and a scramble to harden supply chains against shocks. The recovery has been uneven, however, with some sectors like technology, which can mostly deliver to consumers at home, faring better than industries that require people to share the same space, like bars and movie theaters. 

The auto industry provides an example of this, as the sector all saw significant import declines in the second quarter and rebounded in October by 8.8% year over year. The complexity and length of supply chains has made full recovery a challenge. The subsets of interior, exteriors, and drivetrain increased by 25.1%, 11.5%, and 10.7% year over year respectively – above the total – while road contact systems (suspension) and electrical components increased by 5.9% and 4.8% year over year – below the total. This may indicate that U.S. auto manufacturers have been able to mitigate reliance on foreign road contact and electrical components, or that supplies of these parts from foreign sources are still hard to come by.

Stage 4 Long term recovery plans, aka build back better

Long term, companies are likely to reinforce their supply chains for low probability / high impact events like the pandemic. This may include techniques such as shortening supply chains, including via in-market, for-market strategies, to bring critical supplies closer to target markets. 

Companies will also likely focus more on geographic diversity in their supply chain, rather than multiple bids from companies in the same region. Also expect more care and diligence to be conducted around force majeure and supply stability language in contracts – which overall may increase supply costs to companies.

Finally, companies are likely to be wary of the risk of a resurgence, particularly including mutations such as the B.1.1.7 strain with increased transmissibility. This may prevent companies and the economy from getting past stage three as firms remain committed to “survival mode” supply chains.

Autos recovery distributed unevenly

Chart segments imports of U.S. auto parts on a year over year change basis. Source: Panjiva

The continued risks of medical protectionism

A defining feature of the early part of the COVID-19 pandemic was the rapid rise of medical protectionism as countries sought to reserve supplies of PPE, ventilators and medicines for their own populations. Arguably that tendency has been only partly mitigated for the SARS-COV-2 vaccines with the Covax initiative given most rich countries have signed their own contracts with the major suppliers.

Looking ahead there will be no shortage of plans for a mixture of regional stockpiles, such as the ASEAN+3 project, as well as national critical supply manufacturing plans (see below). Many countries will look for signs of how the Biden administration may implement such a strategy before making their own schemes public, many of which could fall foul of WTO rules. Supplies of PPE and test kits have proven volatile in markets such as the U.S.. 

The global picture for ventilators has exhibited fewer signs of medical protectionism. Panjiva’s data shows that global supplies in the three months to July 31 increased by 87.0% year over year, including a 397.4% jump in shipments from China. 

Shipments got off to a slow start though, with a sequential decline in global shipments in January and February of 3.6% and 13.4% respectively with all major supplier regions having declined, including a 34.0% slide in exports from China. 

The recovery since May has been somewhat inconsistent across regions as governments seek to deal with a series of waves of infection. Indeed, global exports in July likely dipped by 10.8% from their June peak.

Global ventilator distribution accelerated in March, slowed in July

Chart segments global exports of therapeutic oxygen systems by origin on a sequential basis. Source: Panjiva 

Government support for local going global

One of the ways for governments to promote the return of manufacturing to their countries is to provide assistance to companies. While potentially troublesome if challenged at the WTO, many large economies have approached such measures, especially with pandemic creating political pressure to supply PPE and medical supplies locally.

In the U.S. the pandemic response brought $100 million dollars in ‘reshoring funds’ to the U.S. Development Financing Corp. to loan to companies engaged in reshoring efforts. Potential projects include a TSMC semiconductor factory in Arizona, as well as interest from PPE makers and pharmaceutical suppliers.

The Japanese government also allocated money in its pandemic relief package for reshoring, specifically targeting manufacturers moving from China. The country is concerned that imports from China that supply domestic manufacturing could be disrupted during the ongoing and in future pandemics. Companies that are participating in the scheme include Sharp and Iris Ohyama. Japan’s plan is also notable in that it targets China more specifically than others, with money also available to companies that move production from China to other southeast Asian nations.

The Modi administration’s long-running “Make in India” program to boost domestic manufacturing has continued. The program targets 25 sectors including automotive, electronics, and textiles with pushes for foreign investment matched with business reforms. Part of the scheme looks to reduce reliance on China, an issue that came up as border skirmishes escalated in 2020. Some companies that have announced investments under the plan include Kia, Lenovo, and Wistron. Labor issues have clouded the issue in late 2020, in particular given  recent protests at an Apple manufacturing plant run by Wistron. 

China will detail its 14th Five Year Plan for economic development during the first quarter of 2021, including President Xi’s commitment to “self-developed, controllable supply chains“. As with the controversial “Made in China 2025” program the aim will be to reduce foreign reliance on high tech goods across computing, transportation and energy among others. The government may need to walk a fine line between explicit support for state-owned companies and a return to multilateralism in trade policy by the U.S.

The effectiveness of reshoring manufacturing by global firms can be seen in a country’s Foreign Direct Investment figures. Panjiva’s analysis of World Bank data shows that Japan’s FDI rose by 51.2% year over year in 2019 while the U.S. and India expanded by 34.9% and 20.2% respectively. China by contrast experienced a 35.6% decline, though the government’s policies have been driven by self-reliance rather than inbound investment. Data for 2020 should be taken with a pinch of salt as most countries will likely see a pandemic-related downturn.

Japan shows FDI turnaround

Chart segments foreign direct investment in USD to selected countries by year on a balance of payments basis. Calculations based on World Bank data. Source: Panjiva

Bifurcating world – The customer is always right and might is right

The economic aspects of China’s 14th Five Year Plan will be detailed ahead of the March 2021 National People’s Congress, though the broad brush strokes have already been outlined by President Xi Jinping. When coupled with U.S. export restrictions, which may be extended by the Biden administration, the Plan will likely accelerate the process of decoupling between China and the U.S. and with them a need for duplication of many global supply chains.

Two key elements on the Chinese side include an aim to have “self-developed, controllable supply chains“, particularly in technology products, and for economic activity to be driven by the “dual circulation” of both export and domestic consumer demand. 

China’s growth as a consuming nation has allowed it to increasingly call the shots both in terms of product standards and international trading norms. The withdrawal by the Trump administration from multilateral institutions has accelerated that process, though that will likely be reversed under President-elect Biden.

Panjiva’s data shows that mainland China imported $0.86 trillion of electrical and electronics products across industrial and consumer applications in 2019, somewhat behind the U.S. imports of $1.14 trillion. Yet, if Hong Kong is included – as the U.S. now assumes after the imposition of national security laws in the SAR – the Chinese total rises to $1.26 trillion. Both experienced a contraction in 2019, likely as a result of the trade war between the U.S. and China with declines of 1.3% and 5.6% respectively. 

The EU is a larger consumer than both from an optical perspective with total inbound imports of $1.96 trillion, though most of that is internal trade with imports from outside the bloc – an indication of the ability to dictate trade policy terms – being a more modest $0.72 trillion.

China a larger electricals, electronics customer than U.S.

Chart segments imports of electrical and electronics products (HS 84, 85, 87 and 90) by destination. Source: Panjiva 

Retail-Etail, meeting the last mile

The grand sweep of geopolitics is only one aspect of the supply chain landscape that firms need to consider. The overcrowding of logistics networks in late 2020 has also increased the imperative to improve efficiency for in-country distribution. 

One of the ways some retail companies are handling this shift is through omnichannel operations or “micro-fulfillment” strategies. Retailers can use this strategy to consolidate their physical and online presence – online orders can be picked from store shelves and then made available for pickup to the customer, or shipped on to the final destination. This can cut down on warehouse space, shorten the time to delivery for customers, but has drawbacks including employee training and inventory management. 

This retailing strategy may also be in part a response to skyrocketing demand for shipping and warehousing services. Panjiva’s analysis of official data shows employment in warehousing and courier services rose by 7.5% and 18.1% year over year respectively in October and November combined. Retail employment meanwhile fell by 3.2%, extending a decline seen since Q3’17. 

Repurposing retail workers as ad-hoc fulfillment in “dark stores”, such as Macy’s has done, may allow companies to avoid having to upscale their warehousing operations. The need for curbside pickup during pandemic-related retail lockdowns has furthered this strategy, with Walmart providing a tangible example.

Aside from organizational change these strategies require significant technology investments, particularly in Internet of Things enabled inventory systems and related support infrastructure.

Courier and warehouse jobs boosted by pandemic

Chart segments change in U.S. non-farm payrolls by sector. Calculations based on Bureau of Labor Statistics data. Source: Panjiva

Lessons from corporate strategy statements

Corporate supply chain planners have spent the past four years tackling the disparate challenges brought by U.S.-China trade rivalry, Brexit, new free trade areas and of course the pandemic. While some structural shifts are being put into place, in particular cutting imports to the U.S. from China, many firms are still in firefighting mode with true long-term strategies yet to be elucidated. Panjiva’s supply chain research has observed a wide range of approaches which can be swept into four buckets. 

E-commerce accelerated

On the demand side, one of the key differentiators between companies, especially retail, during the pandemic has been the ability to adjust supply chains to accommodate e-commerce needs. Lockdown orders generated a huge demand for delivery services that allow consumers to receive goods from the comfort of their homes. Bark & Co., a service that provides pet toys and treats as a subscription has launched an IPO. Panjiva data shows that imports associated with Bark increased by 91.5% year over year in Q3’20, while data for October and November indicates a 99.4% year over year increase in volume. 

Investments in e-commerce capabilities may not have come cheap, with Urban Outfitters seeing increased costs due “to an increase in delivery and logistics expense due to penetration of the digital channel“ and even companies that traditional sold through brick and mortar channels like tool-maker Fiskars mentioned that they “leveraged some e-commerce opportunities in both the direct and indirect channels” to obtain a 51.3% year over year increase in imports in Q3.

Making the right product helps

Making goods that facilitate social distancing also helped firms that were fortunate enough to produce them. Companies like Logitech that produce productivity tools benefited from high demand from locked down workers – the firm saw 74.4% Q3 increase in revenue. Logitech attributed this to a supply chain decision “in the early days of COVID-19 when we made a supply bet … knowing that we’re going to take some inventory risk“

Toy importer Vtech noted strong results saying “consumer demand has recovered strongly in some markets” with the firm’s U.S. revenues “benefiting from stay-at-home demand for electronic learning toys“. Imports associated with the firm dropped by 23.9% year over year in Q3 2020 followed by a 58.7% surge in October – indicating that there may have been a delay in getting their supply chain sorted out.

Homewares also benefited, for example Tupperware saw a 78.4% year over year increase in imports in Q3. Tupperware attributed the success from increased demand from people cooking at home, and the embrace of ecommerce, saying “pandemic accelerated that, and the addition of new skills on the leadership team also helped.“  

Supply chain restructuring also may have helped firms who are not in a pandemic-compatible market manage the downturn. Samsonite, a maker of luggage, aggressively managed their supply chain to handle the drop in travel, noting, “we’ve been able to move our inventory down almost $100 million year-over-year, which is a testament to our sourcing teams and our supplier organization that we’re working very closely with manage the inventory and the cash flow of the business.“ 

Invest in Stability

Other firms invested in supply chain stability, likely accepting higher costs to ensure that goods would arrive on time and in the right place. Companies across industries used this tactic, for example food wholesaler United Natural Foods noting  “during the past 10 months, the grocery supply chain was stressed” but that they were successful “basically because we have a stable supply chain” as well as “scale to procure new products“. Imports associated with the company increased by 34.2% year over year in the three months to Oct 31.

Fellow food seller BJ’s Wholesale saw imports rise by 15.6% year over year in Q3. BJ’s told their investors, “in-stock levels improved this quarter, and we continue to mitigate supply chain challenges”. The firms were divided in where they invested through supply chain resources however, as United Natural increased sourcing as a percentage of total imports from China from 21.3% in 2017 to 64.4% in 2020, while BJ’s decreased exposure to China from 90.8% to 79.7% in the same period. 

Retailer Qurate stuck with China, facing profits that “decreased primarily due to higher fulfillment (warehouse and freight) costs mainly associated with COVID-related premium pay in our fulfillment centers“. Imports from China associated with the firm increased from 71.7% of imports in 2017 to 78.2% in 2020. 

Manufacturers like Flowserve used the pandemic to rationalize supply chains, saying they used the opportunity to correct “a highly fragmented and responsive supply chain” which didn’t “allow us to leverage consolidated spend across our enterprise”. Flowserve mainly focused their supply chain back on China, with imports from the country increasing by 11.7% year over year in Q3. 

Recreational vehicle maker BRP highlighted some additional challenges faced by pandemic supply chains around logistics, relating to “a situation where we had to airfreight parts or reschedule to accommodate a supplier who had difficulty“ as well as noting that “managing the supply chain those days is a bit bumpy.“ 

Be Nimble

Supply chains that stayed nimble and embraced flexibility during the pandemic also saw success. Stitch Fix enabled e-commerce with a “nimble supply chain will allow us to deliver better client and business results” as well as solid vendor relationships that allowed them to execute on demand, while retailer Guess? simplified their product lines, saying “one global line will enable us to represent our Guess? brand consistently across all markets and significantly reduce product development costs throughout our supply chain.“ The two firms sourcing strategies looked very different however, with Stitch Fix increasing China sourcing from 0% in 2017 to 6.3% of imports in 2020, while Guess? Decreased their exposure to China by 31.5% percentage points in the same period.

Furniture maker Lovesac also emphasised supply chain challenges that were overcome through flexible sourcing, noting “we have three production sources in three countries for Sactional … and we’ve secured additional discounts to offset China tariffs” and attributed success to “our ability to successfully adapt to the changing operating environment“. Panjiva data shows that Lovesac was very aggressive in securing alternate sourcing to China, with imports as a proportion of the total from the country falling by 69.7% percentage points from 2017 to 2020.

HVAC maker Trane consolidated out of China and likely continued a process that started with the U.S.-China trade war. Despite imports falling by 49.0% year over year in Q3, Trane was optimistic saying, “We’re not seeing any constraints in our supply. I think if you go back to the end of March, we reconfigured all of our factories and put the right safety protocols in place.” Chinese imports as a proportion of total imports associated with the firm fell by 11.2% percentage points from 2017 to 2020.

Cutting China supplies hasn’t been a universal strategy

Chart compares share of U.S. seaborne imports sourced from China by importer. Companies grouped by industry. Source: Panjiva

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