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Back to the drawing board – Risk must beat reward in post-pandemic supply chains

Australia 108 Canada 453 China 2778 Cons. Discr. - Apparel 419 Cons. Discr. - Autos 1040 Cons. Discr. - Durables 410 Cons. Discr. - Retailing 375 Coronavirus 479 Corp - Forwarders 301 Corp - Ports 830 Corp - Shipping 880 ESG 46 Energy - Conventional 420 Energy - Natural Gas 135 European Union 722 Global 1279 Health Care 306 Materials - Metals/Mining 674 Metals - Aluminum 214 Metals - Steel 462 Mode - Containerized 1357 Mode - Seaborne 1691 Myanmar 13 Panjiva Insights 43 Tariffs 1720 Theme - Rates 207 Trade Deals 943 U.S. 4944 United Kingdom 316

Panjiva Research is taking part in the Portfolio Construction Forum’s “Markets Summit 2021 – Back to Drawing Board” event on March 3. This report forms the basis of our presentation at that event and will be updated with links to the recording and materials. 

Supply chain decision makers, ranging from buyers to investors, must continue to focus on mitigating risk rather than maximizing growth in 2021 as the world emerges from the COVID-19 pandemic. Logistics disruptions, cost inflation, competition for components and viral mutations overshadow the first half. Further ahead, political risks outbalance opportunities as China flexes its power in Asia, the Biden administration applies what still amounts to an America-first approach, carbon- and digital-taxes abound and new trade deals lead to stronger competition across manufacturing industries.

Seven ways risk has usurped reward – how did we get here? 

The classic Economic Value Add equation provides two routes to adding shareholder value: raise returns (rewards) or cut capital costs. The latter depends critically on reducing both systemic and company-specific risks. In the period after the Great Financial Crisis a decline in the cost of capital may have led many firms to focus more on boosting returns and less on managing risk within the cost of capital.

Events of the past three years have punished such positioning. The rise of economic populism and in particular former President Trump’s trade wars with China and others have added uncertainty and additional costs – in the firm of tariffs – to corporate supply chains. The COVID-19 pandemic meanwhile has revealed four phases of varying risk environments for corporate supply chains which are continuing today, as discussed in Panjiva’s 2021 Outlook.

The first phase, coinciding with the outbreak in China, was an early interruption of supply chains in specific product areas. That led to rapid factory closures in just-in-time sectors including autos but had a minimal effect on the economy at large. Indeed, global export activity in February dipped by just 0.8% year over year when excluding China, Panjiva’s data shows.

The second stage of widespread destruction ran from initial waves of residential and industrial lockdowns from March through July 2020. At its worst, global exports fell by 23.5% year over year in May, or 28.0% excluding China which was already well into its recovery at that point. Few industries’ supply chains were untouched outside of those necessary for the treatment of the pandemic including Healthcare and Home / Personal Care.

The third stage of reopening is continuing and has proven to be far from smooth with interconnected supply chains struggling to restart as the pandemic tightens or loosens its grip. The lag in the recovery of exports from the Americas, which were still down by 0.5% year over year in December even though Asia had returned to growth from August, in part reflects the faltering restart of industrial operations between the U.S. and Mexico as well as the earlier decline in energy commodity prices.

As we’ll discuss below the fourth stage, focused on resilience-building in supply chains including government policy action, is barely getting underway. It’s worth noting that one challenge in the coming months will be “COVID-adjusting” seasonal data – comparisons to prior years may be applicable instead.

China rapidly recovers, U.S. still not there

Chart segments global exports by origin. Source: Panjiva

Cheap Shipping becomes Congested Containers

Corporate supply chain operators have taken cheap shipping as a given for several years. The shipping bust of 2016 and bankruptcy of Hanjin Shipping highlighted the dangers of a commoditized product – container shipping – and a lack of pricing discipline among the large shipping firms.

The past year has seen a very different picture with the container lines showing clear restraint in “blanking” shipping routes when demand was insufficient before diligently passing through surcharges as ports and equipment systems became congested during the economic recovery period. 

The latter has been driven by a surge in demand for stay-at-home consumer goods during the pandemic in western consumer markets, shown by a 73.4% year over year increase in U.S. seaborne imports of home appliances in Q4’20 compared to a year earlier, Panjiva’s data shows. That’s continued in Q1’21 with imports through Feb. 14 having increased by a further 69.3% year over year.

The congested ports have delayed deliveries by weeks or even months with dozens of ships moored offshore Southern California waiting for unloading as port operations are disrupted by staff falling sick or having to care for family members. 

The costs have been widespread. Panjiva’s analysis of Shanghai Shipping Exchange data shows that as of Feb. 19 rates for shipping from China have risen by 135.7% since the start of 2020 and by 24.9% since the start of 2021 leading them to their highest on record. Shipping from China to the U.S. West Coast has risen by 96.0% since the start of 2020, while rates to Europe and Australia have increased by 221.3% and 111.2% respectively. 

The annual shipping contract round ongoing currently will likely bake in higher costs for beneficial cargo owners for the coming year. It may also drive a change in behavior with BCOs likely wanting fixed price, all-in fixed term contracts rather than the more flexible contracts of the past. In that regard higher costs will have to be traded off against lower risk. 

Relief may be some way off. While there has been a surge in new vessel orders so far in 2021 most will not be delivered until 2023. Furthermore, the shipping industry is starting to react to the need to reduce greenhouse gas emissions, likely leading to higher but uncertain costs, with freight forwarders including DP-DHL starting to offer carbon-pricing packages.

Unprecedented surge in shipping rates has yet to abate

Chart segments change in China outbound shipping rates by destination. Calculations based on Shanghai Shipping Exchange data. Source: Panjiva

Dead Inflation becomes Corporate Cost Increases

Combining S&P Global Platts container rates with Panjiva’s shipping data shows that the hypothetical cost of importing goods to the U.S. by sea rose to $6,36 billion in January from $2.46 billion a year earlier. In Q4’20 as a whole the cost rose to $15.8 billion from $6.29 billion, a $9.53 billion increase. In January 2021 alone the cost increase reached $3.90 billion (reaching $6.36 billion from $2.46 billion a year earlier) for one month alone. Indeed, freight costs exceeded the cost of customs duties for the first time.

Commodity cost inflation is also increasing including oil, metals and timber which, when combined with the shipping cost increase, is leading an increasing number of corporations to highlight inflation in their earnings reports since the start of 2021. 

Panjiva’s analysis of S&P CapitalIQ transcript data shows 24.9% of calls mentioned “freight” in January 2021 compared to 15.0% a year earlier. The greatest uptick in mentions of “freight” was among Technology Hardware firms (35.3% of calls mentioned the word in the three months to Jan. 31 from zero a year earlier) while the sector discussing the issue most frequently was Household Durables (55.2% in the past three months from 21.2% a year earlier). While firms are facing higher costs, few have yet discussed how they will mitigate the costs or manage their exposures going forward.

Logistics costs as big a problem as the trade war

Chart compares imputed cost of shipping into U.S. seaports (bars) to total U.S. customs duties (line). Calculations include S&P Global Platts and U.S. Treasury Department data. Source: Panjiva

Cutting the Fat becomes Competition for Components

Short term supply chain management in the autos industry during the pandemic has provided a classic example of why risk management now matters more than pursuing higher returns. Indeed, it illustrates a broader challenge where firms have underestimated the degree to which they don’t just compete with peers in their own industries for components, they often have to compete with other industries. That raises the importance of a risk-first mentality with regards to supply chain management.

A shortage of semiconductors for the automotive sector has led to widespread manufacturing closures: General Motors to close four plants through mid-March; Ford to warn 10% to 20% of output could be lost in Q1’20; Nissan to cut its output target for fiscal 2021 by 3.6% and; Honda to reduce its production targets by 2.2% for the current fiscal year. 

The shortfall was caused by the automakers rapidly cutting orders for semiconductors earlier in the pandemic, apparently not counting on chipmakers reorienting production – which has a six month lead time – towards consumer electronics.

It will take some time to recover with Nissan’s COO, Ashwani Gupta, statingwe do believe that in May or June we should be out of this crisis”. Toyota’s CFO, Kenta Kon, meanwhile is less concerned stating “we do not see any decrease in our production volume” by using high frequency communications with suppliers to reduce the risk of supply chain interruptions. 

Aside from increased supply chain visibility, another solution could be to increase inventories in the future, with Daimler’s Chairman, Ola Källenius, stating “it makes sense in the future to go into more levels of safety stock” according to the Financial Times.

The importance of the automotive sector to the wider economy has also drawn in government intervention which can be both a blessing and a curse. President Biden has signed the long-awaited Executive Order regarding critical supply chain security which will be executed in two stages. 

In the first stage the EO aims to address “production shortages, trade disruptions, natural disasters and potential actions by foreign competitors” for four key sectors including pharmaceutical APIs, critical minerals, semiconductors and large capacity batteries. A 100 day review (through April 6) will “identify near term steps” for Executive and Congressional action “to address vulnerabilities“. There’ll then be a similar, one year review to address the defense, public health, ICT, energy, transportation and goods sectors that will also include Agency actions more broadly. 

Continued plant closures will inevitably have a knock on effect to parts purchases of other items, particularly those within automotive electrical systems that are closely integrated with semiconductors. Panjiva’s data shows that Mexican exports of automotive electrical components climbed 15.6% year over year in December, accelerating from a 10.2% increase in November.

Exporters who have been expanding the fastest may have the most to lose from a sudden grinding to a halt of what had, in prior years, been stable customers. Imports linked to Bosch climbed 106.9% year over year in December while those linked to Lear and Valeo rose by 69.8% and 31.6% respectively.

Auto component recovery accelerating, running into chip shortage

Chart segments Mexican exports of automotive electrical components by shipper. Source: Panjiva

Recovery Rebound becomes Rebuild Requirements

The roll-out of vaccines worldwide is a cause for celebration and optimism that a return to normal economic conditions is possible. However, the timing and structure of the recovery will have significant implications for supply chain planning. 

From a timing perspective the reopening of the service economy later in the year may divert consumer spending from goods during the peak planning, manufacturing and shipping period from June onwards. That will leave considerable inventory uncertainties for retailers in particular. Panjiva’s data for U.S. seaborne imports shows the distortions caused in 2018 and 2019 by tariffs linked to the U.S.-China trade war.

Peak shipping season disrupted for three years

Chart shows U.S. seaborne imports by month. Source: Panjiva

The need to maintain existing sanitary standards in manufacturing and logistics, which have cut productive capacity, is likely to persist even in the absence of further mutations of SARS-COV-2 already seen in the U.K. and South Africa. 

Personal protection equipment (PPE) supply chains in that regard have provided a number of cautionary points. A persistent level of medical export protectionism has continued even a year down the line from the pandemic, with 121 restrictions globally compared to a peak of 177 not allowing for the EU’s vaccine export scheme. 

The emplacement and exemption of tariffs on face masks – as well as a potential exemption lapse, Bloomberg reports –  has created cost risks for buyers. There’s also been short-term disruptions to supply chains in rubber gloves due to forced labor accusations linked to supplies from Top Glove. Panjiva’s data shows U.S. seaborne imports of rubber gloves linked to Top Glove dropped by 83.1% in September versus their July peak with the result that total U.S. seaborne imports over the same period only rose by 2.3%. That was due to a 39.4% rise in shipments linked to Hartalega and a 26.5% increase in shipments associated with Sri Trang. 

Rubber glove imports prove volatile on global demand, customs orders

Chart segments U.S. seaborne imports of rubber gloves by shipper. Source: Panjiva

China Growth Engine becomes Newly Muscular China

Historically China has provided both a source of low-cost manufactured goods and a market for commodities and other specialty products. More recently though, whether with Australia over the origins of the coronavirus or with Canada over Huawei, China has taken a more muscular approach towards foreign relations with a potential impact on the exports from and supply chain activity in those countries. 

Australia’s exports in the aggregate have expanded by 13.0% year over year in January 2021, including a 13.2% increase in shipments to China, Panjiva’s analysis of official figures shows. That would suggest a limited impact from China’s trade actions, though that has been covered in large part by a surge in Australian exports of iron ore and cereals which rose by 53.5% and 67.9% respectively. Among products that have been specifically targeted there’s been a notable drop with exports of beverages and fish down by 38.8% and 58.9% respectively.

A push by the Biden administration to pursue a more multilateral approach to geopolitics with China further increases the risks that the political and economic spheres will clash. U.K. government actions in regards to 5G telecoms and the designation of alleged human rights abuses within trade deals, are a potential source of future conflict. 

There’s no shortage of other trade policy brushfires for supply chain decision makers to navigate even if the opportunities presented through new trade deals such as RCEP and an expanded CPTPP are significant. 

Australian food, drink exports suffer after China’s tariff actions

Chart segments Australian exports by product. Calculations based on Australian Bureau of Statistics data. Source: Panjiva

America First Unilateralism becomes America First Multilateralism

Cost minimization has been the central mantra of supply chain construction throughout the past three decades, accelerated by China’s accession to the World Trade Organization in 2001 and by a steady shift to low labor cost countries for basic assembled products (furniture and apparel) and centralization with economies of scale in more complex areas (telecoms products, consumer electronics).

The implementation of tariff-led trade policies by the Trump administration upended many of these plans and led firms serving the U.S. market with the need to offset tariffs through methods ranging from price increases and burden sharing through supply chain restructuring and legal actions. 

The tariffs have certainly proven effective in cutting U.S. imports of afflicted products from China. Panjiva’s analysis shows that imports of “list 1” and list “2” products (tariffs applied at a 25% rate since July and August 2018 respectively under the section 301 program) that are central to supply chains having fallen by 29.5% in 2019 compared to 2017. Subsequent improvements have largely reflected increased purchasing of COVID-19 related products as well as exemptions granted where firms can’t avoid tariffs. Imports of list 1 and list 2 products were nonetheless 31.7% lower in Q4’20 versus Q4’17.

The advent of the Biden administration may have brought a change in tactics, but the broad brush aims of focusing on U.S. employment levels and supply chain security are unchanged. Biden is also in no rush to remove tariffs either on imports from China or other products including steel, aluminum, solar panels and even washing machines where the Trump administration used tariffs.

When combined with the administration’s new Executive Order regarding six critical industries there remain considerable risks around the right way to construct supply chains to serve U.S. commercial and industrial demand with options ranging from onshoring to “friendshoring” (locating in closely politically allied countries) or simply diversifying to reduce risk.

Trump’s China tariff damage proves persistent

Chart segments U.S. imports from China by section 301 tariff list. Source: Panjiva

Maximizing Returns and Reacting to Risk becomes Managing Risk and Optimizing Returns

There’s been the emergence of risks beyond the pandemic that raise real concerns for supply chain operations and challenge ongoing assumptions about the right level of risk in at least three areas: environmental risk; political risk; and logistical risks.

From an environmental perspective there’s been ample evidence of the effect of extreme weather on supply chains from the recent cold weather afflicting the southern U.S. While not demonstrably caused by climate change they do shine a light on the effect of a lack of preparedness and focus on short-term cost minimization. Industries as varied as LNG exports, automotive assembly, furniture construction and steel production all faced several days of closures as a result of the Texas storms. 

Spending on greenhouse gas reductions will also scale up with uncertain rates and distribution. The steel industry is particularly exposed in terms of carbon border taxes in the EU, the implementation of the Biden administration’s environmental policies and global decarbonization commitments that may come to ahead at the UNFCCC COP26 to be held in the U.K. in November. The EU, U.S. and China accounted for 48.1% of global steel imports in 2019 and will drive the direction and speed of travel for GHG emission reductions.

Political risk also remains elevated and can only be effectively mitigated by incurring additional costs through diversifying sourcing. The recent coup in Myanmar has compromised apparel and luggage supply chains for firms including Adidas and Samsonite, both of whom had increased U.S seaborne imports from Myanmar with growth of 33.0% and 84.5% year over year respectively in Q4’20 before cutting shipments in January. H&M meanwhile has been steadily cutting back already. Even putting aside reputational issues, the current protests have disrupted economic operations in the country. Hapag-Lloyd has decided to “temporarily suspend any import bookings into Myanmar” due to port congestion linked to the disruptions caused by “continuous daily protests“.

Even if political and policy risks can be managed, there’s still underlying logistics risks with operating extensive, cheap but fragile supply chains. Those have been brought home in 2020 and 2021 with a series of cybersecurity attacks – including those against CMA CGM and Forward Air which halted their operations – and more recently a spate of container losses-at-sea which have beset ONE, Evergreen and Maersk (twice) among others. While accidents happen, their impact can be mitigated through the use of robust, visible supply chains – even if that comes at the cost of reduced profitability in the near-term.

Myanmar provides seasonal supplies in apparel, luggage

Chart segments U.S. seaborne imports of apparel and luggage from Myanmar. Source: Panjiva

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