Q1 2022 Market Watch: Upstream Supply Chain Disruption

February 8, 2022

Compounding logistics challenges continue to result in empty physical and digital shelves.

Market Watch Header Image Feb2022

Companies are re-evaluating their sourcing, manufacturing, transportation, and inventory management practices to improve in-stock rates of critical goods and products. Finding the right balance of ‘just-in-time’ and too much safety stock is a magic formula no one seems to have solved.

Key Takeaways

  • 60% of consumers have recently encountered stockouts
  • 70% of those who did, switched brands instead of waiting for the product
  • Retailers lost $4.6 billion from stockouts during 2021's Black Friday shopping event
  • Countless upstream supply chain challenges are resulting in these costly logistics failures

Last year wasn’t easy. Companies’ ability to get goods to market suffered against the backdrop of plant shutdowns, port delays, and record-low industrial vacancy rates. Stockouts soared, and the problem still lingers. Empty shelves—both physical and digital—mean lost sales and brand loyalty.

Meanwhile, the personal consumption rate of durable goods continues to reach new highs. As a result, consumers are more likely to switch brands to find what they need instead of waiting for in-stock inventory. According to a recent McKinsey survey, 60% of consumer respondents ran into stockouts. Of them, 70% switched brands, and only 13% said they waited for restocks.

Retailers and brands face major financial implications from stockouts. Empty shelves cost retailers and brands tens of millions of dollars each. On Black Friday alone, retailers lost $4.6 billion from stockouts, with as many as 55 million shoppers unable to purchase products as intended, eroding loyalty at a retailer and brand level.

Around the Black Friday shopping surge, the Customer Inventories Index hit 25.1—the second-lowest point since the index began—demonstrating that inventories were too low to support robust consumer demand. While levels increased in December, rates are still below historical precedent.

Because of widespread stockout issues and the stakes tied to them, companies are re-evaluating their sourcing, manufacturing, transportation, and inventory-management practices to mitigate upstream disruptions and improve in-stock rates. However, striking a balance between ‘just-in-time’ inventory and too much safety stock remains key to solving today’s supply chain volatility.

Challenge: Upstream supply chain issues create a domino effect #

Every mode and node in the supply chain is under duress. Manufacturing underwent a systemic shock at the beginning of the pandemic as factories in China went offline, starting a domino effect throughout the global supply chain that continues today.

Demand imbalances are everywhere, and they affect the entire supply chain. From sourcing to imports to domestic transportation, all links in global commerce face dislocation. Subsequent disruption compounds through each mode, which ultimately results in stockouts and lost customer loyalty.

Input costs rose above the 14.5% average, which acutely hit apparel, leather, and allied products.
PR Newswire, December 2021

Sourcing and raw material difficulties compound manufacturing delays #

Volatile commodity costs and geopolitical pressures increased average material prices in 2021. Lead times for production improved in December but are still near record levels at 91 days. Simultaneously, input costs rose above the 14.5% average, which acutely hit apparel, leather, and allied products.

Piling on, Covid-related plant shutdowns and delays in manufacturing that have stopped and started since the beginning of the pandemic have impacted supply as inventory couldn’t hit the shores. Simultaneously, demand skyrocketed, and manufacturers have played catch-up since. Despite efforts to correct production, sectors are still unable to get ahead of consumer demand.

The industry could face a shortage of 160,000 drivers by 2030.
American Trucking Association, December 2021

Ocean Freight: Imports and Exports Distribution #

The ocean freight and import market also remain a significant challenge for retailers and brands. Similar to the issues in manufacturing, ocean transport has faced difficulties for the past two years.

Following the shutdowns that curbed the flow of goods from Asia to the U.S., demand jumped to unprecedented levels, resulting in record volumes. The surge at U.S. ports has created a collective bottleneck that has yet to clear.

Despite record processing efforts at the ports, the logjam persists. In 2021, The Port of Los Angeles handled 10.7 million 20-foot container units in 2021, 13% more volume than in 2018, which was the previous record year. In the middle of January, there were still roughly 100 vessels waiting to be processed. Labor shortages, difficulties with Covid, and continuing import volumes are preventing progress.

Middle-mile transportation delays #

Once vessels at the ports are processed, their freight makes its way to the domestic trucking market. After an early-pandemic volume dearth, the middle-mile transportation market grappled with continuous all-time highs, affecting several sector inputs.

Notably, the transportation sector is facing struggles processing import volume. Fresh freight records have inundated warehouses, resulting in a chassis shortage. As warehouses struggle to meet demand, trucks process through facilities slower than normal, which results in boxes left on chassis for days.

For example, pooled chassis at the Southern California ports were held outside the port in September 2021 for more than nine days, on average, double the time they were occupied before the coronavirus pandemic.

Likewise, the intermodal and rail markets felt pressure from the surge. During the first half of 2021, railroads handled the highest volume of intermodal traffic ever moved in a January-June period. Some weeks in late 2020 and the first half of 2021, U.S. railroads were handling more than 300,000 containers and trailers per week, levels that no one expected when the pandemic began.

The dwell time for containers at 11 major railroad depots reached an average of 9.8 days in September 2021, according to a tally of its own boxes maintained by Hapag-Lloyd AG, the world’s fifth-largest container carrier. That’s up from 6.7 days in May and 5.9 days in February in the same year.

These disruptions have drastic downstream effects and often manifest in late deliveries and out-of-stocks. While some are taking steps to add capacity, a significant source of the problem is the driver shortage, which jumped 23% since the pandemic. Moreover, the industry could face a shortage of 160,000 drivers by 2030.

Warehousing Capacity

Industrial real estate fell unabated for several months. It went from its previous all-time low at 4.8% to 3.2% in Dec 2021. For context, its most significant plunge before the pandemic was 5% in 2018. The current rate means space is at a premium and hard to come by in major markets. When combined with labor issues persistent across providers, warehousing is a challenge for retailers and brands.

How different companies are adapting inventory strategies because of the upstream pressures #

Since the initial shock of disruption in March 2020, retailers and brands have pivoted strategies atypical to pre-pandemic. They are accumulating more inventory, placing larger orders with suppliers, tightening SKU mixes, speeding up distribution networks, and bringing as much of their supply chain to the U.S. as possible. While these trends started out of pandemic-era necessity, they may outlive other impacts.

McKinsey surveyed shippers in May 2020, asking about where they planned to address ongoing pandemic-related disruption. McKinsey then re-surveyed shippers in 2021, inquiring about actual implementations over that time. The below chart compares the two sets of data, showing that initial plans in May 2020 focused mainly on nearshoring-related strategies. The chart below demonstrates how market volatility impacts retailers’ and brands’ planned versus actual implementations.

Market Watch Feb2022 Chart 1 Blog
Inventory levels have come up a bit, but not to where they should have been to offset the impact of COVID-19 or create any sort of supply chain resilience.
Professor of Supply Chain Management at ASU, Dr. Kevin Dooley, PhD.

There isn’t a single solution #

The truth is, there isn’t a single solution to the upstream supply chain disruptions happening across the industry. Here are several approaches shippers are taking.

Bulk buys / Pack and hold

Previously, lean principles were present in every sector’s supply chain management strategies. But as shortages gripped the pandemic economy, the practice drew ire from analysts. Retailers and brands alike did not have enough of what they needed on hand.

“If you look at the inventory-to-sales ratios for U.S. manufacturing in the 1950s and 1960s, there was a lot more inventory on hand,” said professor of supply chain management at ASU, Dr. Kevin Dooley, PhD.

“In the early 1990s, right around the peak of the lean manufacturing movement, there was not. Since then, inventory levels have come up a bit, but not to where they should have been to offset the impact of COVID-19 or create any sort of supply chain resilience.”

“Basically, you need some kind of buffer. I’m not saying lean manufacturing is bad, but in some ways it’s gone too far. We’re seeing the implications of that now.”

As the second anniversary of the pandemic nears, brands are rethinking their reliance on lean. For critical components, companies might agree to order one or two years of stock from a supplier rather than 12 to 14 weeks to ensure they have products available. This stock enables manufacturers to continue production even if they cannot to procure enough critical materials from suppliers.

Similarly, Nordstrom is increasing its use of pack and hold inventory "by a factor of two times to three times at its Rack subsidiary” as it expects macro supply chain disruptions to persist into 2022. The approach will allow the retailer to purchase larger than needed quantities when they are available. It will then deploy the held stock when demand exceeds supply, allowing them to meet customer expectations even when suppliers cannot deliver products.

By focusing on producing and carrying faster-moving SKUs, Under Armor's revenue was up 35% in YoY comparisons from 2020.
Retail Dive, December 2021

SKU simplification #

Some retailers are enacting SKU-simplification strategies to reduce the diversity of their inventories and focus on consistently getting high-velocity sales products on the shelf. However, fewer companies actually did in 2021. According to the above McKinsey surveys, in 2020, 30% of respondents planned to reduce SKUs. But in 2021, 15% did.

Under Armor was among the 15% that implemented SKU reduction, and the apparel company has reported significant success as a result. By focusing on producing and carrying faster-moving SKUs, the company’s revenue was up 35% in YoY comparisons from 2020.

Safety stock #

Building safety stock has been a hotly discussed topic since the onset of Covid-19. However, due to upstream challenges, many were unable to bring inventories up in 2020. As companies now have had more than a year to adjust to pandemic-induced shocks, this goal is becoming a reality, assisted by more consistency in the marketplace and slightly waning consumer demand. Per McKinsey data, In 2020, 47% said they planned to increase inventory. In 2021, 61% of respondents said they did.

Moreover, according to the Logistics Managers’ Index (LMI), inventory levels hit year-long highs during the holiday season. During 2021's final month, inventories rose to 61.6 in the LMI, an increase compared to a year earlier when the reading was 56.8. It's also well above the 42.3 figure recorded in December 2019. Supply chain professionals expect this number to climb again in the year ahead as companies build inventory levels.

Supplier diversification and nearshoring

Nearshoring operations is another strategy pushed into the forefront by pandemic-related supply chain disruptions. According to the McKinsey survey in 2020, 40% said they planned to increase their supplier base and adopt a nearshoring strategy, yet by 2021, just 15% had implemented such strategies.

The reason for the discrepancy in implementation likely resides in the difficulty of nearshoring. While it may benefit some sectors, like medical device manufacturing, others may find it cost-prohibitive or otherwise unfeasible. Bringing sourcing partners or manufacturing closer to end-customers enables greater supply chain control; however, whether it makes sense for a company is often sector- or firm-dependent.

Speeding up distribution network speed #

Finally, companies have aimed to regionalize their distribution networks to speed up the distribution process. When initially surveyed by McKinsey, 25% of respondents stated they intended to take steps to tighten their distribution network. One year later, 38% had done so.

By adding nodes or relocating fulfillment centers closer to demand, companies can consistently get products to the shelf. Moving operations closer to customers enables brands to reduce inventory touches, middle-mile transportation distances, and optimize for last-mile ground delivery.

Transportation accounts for the largest share of order cycle time variability in most supply chains, thus affecting inventory levels, stockout costs, and on-time delivery. Optimizing fulfillment networks to utilize as little middle-mile transportation as possible increases distribution speed.

Load balancing: The implications of holding too much inventory #

As the year unfolds, it’s possible that market dynamics shift. Consumer sentiment tumbled to its lowest level since 2011 in January as the U.S. grapples with inflation concerns. While not a direct predictor of economic output, the number suggests people may be pulling back from their spending habits, which drove some disruptions. Likewise, the personal savings rate has been contracting, indicating people may be less inclined to buy as they have the past two years.

That could mean the demand driver in the supply chain disruption equation falls flatter, leaving businesses that have been stocking up with more inventory to carry. These levels of inventory-holding strategies are unprecedented in supply chain. They come with higher costs, less certainty, and require more warehousing and transportation capacity, which is starkly different from typical supply chain objectives.

However, given the unreliability of inventory deliveries, companies are in a tough spot. They need production-critical or finished goods to ensure sales growth, making it clear why they’ve been increasing inventories since 2020.

While there isn’t a universal answer to the challenges that brands and retailers face in 2022, the best fit for a company depends on business realities and customer needs. Stay tuned to the Flexe Institute to see how shippers and service providers navigate ongoing supply chain disruption.