How Does a Business Deal with Supply Chain Issues in 2022?
As companies and lenders evaluate performance risk and expectations for 2022, the trends previously considered to be emerging need to be considered a permanent part of the 2022 business environment. At this point, it is unrealistic to expect supply chain stresses to disappear in 2022. Businesses will need to develop tools to plan for and manage through supply chain issues. In this article we will first review supply chain indicators, and then discuss approaches business management can take to survive and thrive in this environment.
Supply Chain: ISM Indices
The Institute for Supply Management (“ISM”) reported the December 2021 Manufacturing ISM at 58.7%, which is the nineteenth consecutive month of growth. While the rate of growth slowed from the 61.1% reported in November, economic activity continues to show growth with survey respondents saying they have a positive outlook for 2022.
The December 2021 Services ISM also reported the nineteenth consecutive month of growth at 62.0%. This brings the Services ISM down to the September 2021 level of 61.9%, after experiencing a spike to 74.8% in November. The Services ISM reported five record growth months in 2021.
Further analysis of the data reported in the December 2021 Manufacturing ISM shows the following:
New Orders Index was 60.4%, down when compared to 61.1% in November.
Production Index was 59.2%, down when compared 61.5% in November.
Prices Index was 68.2%, down when compared to 82.4% in November.
Backlog of Orders Index was 62.8%, up when compared to 61.9% in November.
Employment Index as 54.2%, up when compared to 53.3% in November.
Supplier Deliveries Index was 64.9%, down when compared to 72.2% in November.
Inventory Index as 54.7%, down when compared to 56.8% in November.
New Export Orders Index was 53.6%, down when compared to 54.0% in November.
Imports Index was 53.8%, up when compared to 52.6% in November.
Fifteen manufacturing industries reported growth in December. These included Apparel, Furniture, Textile Mills, Plastics & Rubber, Machinery, Nonmetallic Mineral Products, Misc. Manufacturing, Chemical Products, Electrical Equipment, Appliances, Fabricated Metal Products, Computer & Electronic Products, Food, Transportation Equipment, Primary Metals and Petroleum & Coal.
Three manufacturing industries reported decreased activity in December. Those were Wood Products, Printing, and Paper Products.
The December 2021 capital expenditure lead time days was 161 days, which is a steady increase from 154 days in September 2021. The December 2021 production materials lead time days was 91 days, which is a decrease from the 96 days reported in October and November 2021. The December wait time for supplies used for maintenance, repairs, and operations (“MRO”) increased to 48 days from 44 days in November. The MRO lead time in days has been varying between 44 / 45 days and 48 / 49 days since September.
ISM completed its Semiannual Economic Forecast survey and released the information in December. The Semiannual Economic Forecast reports demand will expand, based on growth in the New Orders Index and New Export Orders Index, Customers Inventory Index at low levels, and Backlog of Orders Index at high levels. Consumption will also increase as indicated by the Production Index and the Employment Index.
The ISM survey expectations for 2022 show the following:
Revenue up 6.5%.
Capital Expenditures up 7.7%.
Capacity Utilization is at 88.7%.
Revenue up 4.3%.
Capital Expenditures up 10.3%.
Capacity Utilization is at 89.4%.
Expectations are for revenue growth in 15 of the 18 manufacturing sectors and for revenue growth in 17 or the 18 service sectors.
The manufacturing employment base is expected to grow 1.0% in 2022.
The December 2021 comments from industry executives and the comments in the 2022 forecast survey report a lessening of labor issues in terms of finding staff; however, the executives are concerned about retaining existing employees and backfilling for employee turnover. This economy is an employee’s market, rather than an employer’s market.
Supply Chain: Freight Indicators
Marine Transport Indicators:
The Freightos Global Container Index as of January 21, 2022, reports an index value of $9,680 compared to the high of $11,109 on September 10, 2021 and the $4,400 to $4,700 reported from February to April 2021.
Looking at the Freightos China to North America West Coast index, the January 21, 2021 value is $15,145 per container, compared to the November 5, 2021 value of $18,730.
The year over year index value for the November to January period shows that last year container costs from China to the Western US were in the $3,843 to $5,205 range compared to 300% higher this year for the same period.
Clearly the marine transport costs are off the peak values hit in September of 2021; however, the marine transport costs are increased over both the prior year and run rate historic levels. This indicates the increased marine transportation cost levels should be expected to continue, though the costs may be off their highest points.
DAT Freight and Analytics reports trucking industry activity and costs. In the Resources section of their website, DAT.com, DAT publishes trendline data for rates and fuel costs. This shows that January 2022 over January 2021 rates increased as high as 64.6% for Reefer Load-to-Truck, with most year over year rate increases in the 25% to 35% range. Fuel prices increased 40.9% year over year.
Typically, spot rates decline in January, but according to DAT that did not occur in 2022, with van, flatbed and reefer spot rates all increasing in January 2022.
Industry participants continue to cite labor shortages and rising labor rates as issues they are working to overcome. As with supply chain discussions, the labor retention rates and the labor backfill costs are driving increased stress for companies that are involved in the transportation of goods via truck.
A business that operates its own fleet or relies on outsourcing for trucking needs should expect transportation costs to continue at least at the current level throughout 2022, though the trends are suggesting costs may continue to increase in the short term.
Air Freight Indicators:
The Baltic Air Freight Index shows that air freight rates have continued their steep climb and are highest for the Hong Kong to North America rates. These rates have increased from $4.00 per kg to over $12.00 per kg.
A business that relies on air freight will need to expect continued high costs, with the strong possibility that trend has not yet leveled off.
What does this mean for a business?
These statistics show that businesses should expect their supply chain cost stresses to continue throughout 2022. The labor issues coupled with transportation costs will contribute to financial stress and to timeline planning and delivery issues. The financial impacts of the supply chain cost increases will stress the financial performance of the company.
The timeline issues will also result in working capital stress as businesses struggle with the tradeoff between costs to carry raw materials and finished goods versus the risk of being unable to meet order demand. In contrast to just in time inventory methods, businesses are now feeling the need to Increase levels of raw materials and finished goods to ensure the ability to produce and ship orders on time.
What tools should a business use?
Dealing with supply chain issues means the business will need to address both financial performance risks and working capital needs.
Senior management will need to engage a team consisting of logistics, inventory management, operations, and sales to evaluate how best to respond to the supply chain stresses. This will involve developing creative methods of dealing with customers, vendors, and material suppliers.
Customer contracts will need to be evaluated for transportation related requirements and impacts. For example, if trucks are not available to ship product to customers, is that the company’s problem or the customer’s problem? How will the company be impacted by product manufactured to purchase order that is remaining in inventory?
Transportation contracts will need to be evaluated for potential cost increases, specifics regarding FOB terms, capacity requirements and limitations, and potential damages if terms are not met by either party to the contract.
The income statement impact of supply chain costs may contribute to inflationary cost changes in multiple line items of the incomes statement. In addition to reviewing and planning for changes in transportation line items it will be important to consider the impact of changing transportation costs on each expense line.
A thorough review of the income statement will be necessary to identify financial performance risks.
While supply chain costs will certainly impact the income statement, many businesses will overlook the impact on working capital and, therefore, will be surprised by the cash needs and the impact on financing costs and credit availability.
There will be a tendency to move toward increased inventory levels for both raw materials and finished goods. It will be important to evaluate items such as packaging materials that may be customer specific. If the contract with the customer does not have the ability to push the increased packaging inventory needs back to the customer, making that contractual change should be evaluated. If the customer provides purchase orders and then is unable to provide trucks to pick up inventory, will the customer or the company producing the product be responsible for carrying the inventory.
Suppliers may ask for faster terms to support their own working capital needs. Customers may ask for slower terms to support their needs.
All these changes and stresses need to be evaluated for their impact on the operating cycle and on cash flow. If a company has a few key customers, developing an operating cycle for each customer will be important as the company evaluates costing and working capital needs. For example, if a customer has an operating cycle of 60 days, the carrying cost of the working capital for that customer should be considered when pricing the product the customer purchases.
The line of credit structure will also need to be evaluated in conjunction with these supply chain issues. There may be changes required in certain areas of the line of credit structure, such as:
Relationship limits between accounts receivable and inventory.
Concentration limits within accounts receivable.
Sub limits for inventory components.
Cross aging exclusions.
Weekly cash flow and working capital modeling is key. This weekly performance tracking also helps identify problems quickly, as weekly budget to actual reporting will show changes before the income statement or balance sheet for the month end are reported. Weekly tracking would immediately show cash flow and working capital changes that would be early indicators of:
Sales changes, to allow drill down by customer.
Collections changes for terms and discounts.
Inventory increases or decreases, to allow drill down by inventory category and by customer.
Accounts payable changes for terms and discounts.
The supply chain stresses make working capital management a key component of successful business operations in 2022. This will be a challenging year. Many controllers and CFOs, as well as their accounts receivable, inventory and accounts payable staff have not been through this level of stress and may not know what early indicators to look for.
When supply chain issues are combined with the level of inflation, commodity price changes, and labor issues, most company managers have not experienced this stress during their working career. For example, with inflation at a 40 year high, the number of managers that have experienced these business dynamics is low, and a specific manager’s understanding and skills have not been tested in this economic environment.
Planning and analysis are ways to reduce performance risk and identify areas for possible improvement or change before a company drops into unsustainable performance levels. Senior management of a company needs to be considering, evaluating, and planning for these trends to continue.