The supply chain challenges facing businesses today

By David Buxton, industrials analyst at finnCap Group

The Ukraine invasion is the latest in a line of challenges that managements have had to overcome over the past two years. The greatest challenges have centred around the well-aired issues of supply chain disruption, inflationary pressures, labour shortages and – more recently – the jump in energy prices. Looking at supply chain issues specifically, concerns around the cost and availability of cargo vessels during the pandemic have evolved due to several factors.

Any company’s individual experience will be determined by the point in the global supply chain they operate in and what their end markets are:

– Businesses that gain many of their inputs from suppliers in the Far East have arguably been worst affected.

– Products that require semiconductors have had their own particular problems in the supply of chips.

– Just-in-time businesses will have experienced an impact on production almost immediately unless they introduced buffer stocks that protect them.

– Long order book businesses have arguably some leeway in adjusting their input ordering schedules, or indeed changing their suppliers if needed in order to get supplies to arrive in sufficient time.

Supply chain challenges and pricing pressure so far

The initial indications of pressures building in the economy were already apparent as we moved into the post pandemic recovery phase. Stepping back from the commotion, the problem is that supplies have not recovered in lockstep with demand and disruptions have been exacerbated by recurrent local lockdowns and restrictions, such that activity has been volatile and difficult to predict and prepare for. Companies best able to cope with volatility have a very flexible operational base and used their liquidity to increase strategic inventory.

These stresses in the supply chain have intensified across a number of indicators – I don’t like the phrase but it has been an almost perfect storm, with pressures in base metals and commodity raw materials, energy costs, transport and freight costs, dislocation in logistics and shortages in labour.

By and large, the industrial technology sector has fared surprisingly well in the circumstances. This has been achieved with companies deploying their cash to build buffer stocks to protect lead times and customer delivery schedules. Those without financial flexibility may have experienced disruption to deliveries and potentially lost some market position.

Input price increases have generally been passed on to customers, albeit with some temporary time lag effects seen on many companies’ margins. Companies generally play catch up. Some companies have escalator clauses built into customer contracts, but these tend to be the minority of cases. Short-order cycle business is generally more fluid. Companies with long lead times may be experiencing a squeeze, while those who have placed orders for commercial infrastructure projects will have seen higher capex costs resulting in lower-than-expected paybacks, and some infrastructure projects will require additional injections of funding – which may cause delay or altered specifications.

The automotive sector is notorious and characterised by its just-in-time business models and reliance on its supply chains to achieve maximum flexibility achieved for a meagre margin reward. Recent comments in a BBC interview by the Chairman of Ford Europe, Stuart Rowley, highlighted the need for automotive business models to evolve, with greater flexibility and more robust supply chains, and closer collaboration with their tier 1 and tier 2 partners.

A possible destocking phase

There is an expectation that companies carrying higher than normal levels of stock may move into a phase of destocking if market demand drifts off. This could have a greater ripple impact on raw materials and commodity manufacturers through the mid-year. This may prove an optimistic timeframe as the Ukrainian situation may defer this phase.

Reshoring and reducing supply chain fragility

Reshoring, or near-shoring, was a trend in existence well before the pandemic and Brexit, but was only a fairly marginal theme in the UK for most manufacturers at that point. Earlier reshoring started to rise on the industrial/political agenda in the US due to Trump era restrictions and sanctions on China, which have been retained by the Biden administration.

It is clear that there are a number of separate but often linked issues surrounding supply chains and logistics that have caused many companies to change the way they look at their supplier base. Until recently we lived in a broadly deflationary world, pushing demand to Far Eastern manufacturers, extending delivery transit times. Recent volatility has placed a keen focus on certainty of stock and raw material availability.

We have seen companies adopt three strategies to improve flexibility and security:

1. Dual sourcing to provide greater flexibility and reduce the specific risk with single sourcing. This may be an option with a primary and secondary source.
2. Strategically reviewing suppliers and where possible bring them closer to home, lessening both time in transit as well as reducing soaring freight costs. We have recently had companies comment that their customers are now willing to see a slightly higher price associated with manufacturing in western Europe in order to increase supply security.
3. Holding additional inventory on the balance sheet as a longer-term insurance policy on stock availability. This is often a short-term stop gap but is inappropriate as a long-term solution. It will also consume cash and reduce balance sheet efficiency.

Predictions a few months ago may have been felt to be overly gloomy; they now appear to have been on-the-money and, in some respects, even optimistic, believing these to be just temporary blips. Now these issues look set to last several quarters. It is quite clear that these price pressures and supply chain challenges have accelerated in intensity and now are top and centre of both the business and political agenda.