The times they are a-changin’

VT Tyndall Global Select Fund

The times they are a-changin’

For much of the past half century companies have sought to globalise their supply chains and move closer and closer to just-in-time delivery systems. These developments allowed companies to operate on lower levels of inventory than in the past, reducing the amount of working capital required to run the business and therefore increasing the free cash flow generated by the firm. The pandemic, and the financial crisis before it, however, showed just how fragile these systems were and have caused many firms to rethink their whole supply chain strategy.

Company management teams are now starting to grapple with keeping costs to a minimum but also making sure supply chains are robust and not just efficient. The events of the past few years have shown the failings of overdependence on certain suppliers or jurisdictions. These problems came to the fore after the Trump administration placed wide ranging sanctions on China (and the Biden administration has done little to roll them back), but the pandemic led to issues over port congestion, semiconductor, and labour shortages as well as many examples of force majeures being implemented. The recent conflict between Russia and Ukraine has highlighted that these concerns are not only felt at the corporate levels, but also at the national one, as dependence for energy and food supply came under scrutiny. Janet Yellen, the US treasury secretary summed up the issue, stating that “we cannot allow countries to use their market position in key raw materials, technologies, or products to have the power to disrupt our economy or exercise unwanted geopolitical leverage”.

The World Bank Group reports that global trade in goods and services as a percentage of global GDP rose from 25% in 1970 to a peak of 60% in 2008, and prior to the pandemic stood at 56%, and the chart below from the United Nations Conference on Trade and Development (UNCTAD) shows how strong world the trade between nations remains.

Reshoring and nearshoring have been regular topics of discussion in recent times, as a way of safeguarding supply, but given the extent of globalisation, a policy of reassessing the jurisdictions of supply and diversifying suppliers by broadening the list of trusted suppliers is more likely. Vertical integration by buying key suppliers and distributors remains an alternative option, especially as the world becomes more interested in the traceability of goods from cradle to grave, as is internal manufacturing. The chart below from a survey conducted by McKinsey & Co shows how companies are increasingly looking at multiple ways to solve the supply security issue, and while nearshoring features, inventory building, and dual sourcing has more traction as solutions from the supply chain executives polled.

The costs involved in moving production centres or undertaking greenfield investments tend to be large, so any decisions to onshore or nearshore must be weighed against the other alternatives and may take years to implement. As is evident in the semiconductor space, under pressure from the US and European administrations on the wafer manufacturers to have local production sites, in order to reduce the reliance on Taiwan and China, the world will not see meaningful output from the western world for a further three to four years despite the large incentives coming from the respective governments.

In order not to be found short of key components, as many companies discovered during the pandemic, is a problem that can take many years to rectify, and management teams and investors alike are unlikely to forgive the same problem happening again in the near future. As a result, there are many examples where suppliers of these key components are seeing their order books at record levels as supply executives are often double or triple ordering to safeguard their inventories, further exacerbating the delays in delivery times for the items.

While we expect dual or multi sourcing to become the norm as resilience and redundancy rise up the priority list, this is likely to have significant cost implications, however, bottlenecks will still be a part of global supply chains, as it will not be able to find alternative suppliers for every item and certain relationships are key. In the FMCG world the taste, smell and touch of products mean that your contract with your flavour and fragrance supplier is essential unless you are prepared to reformulate and risk having a negative customer as the product is different to what they are used to, or in manufacturing many components are so specialised and design specific the cost and time for an alternative supplier may simply not be feasible.

Globalisation is not going to disappear, even if we do see a slight increase in near or onshoring, but the past increased investment in locations such as China are likely to be at lower levels than in the past. Regions such as Mexico, Vietnam, Indonesia, and Poland have already seen some benefits from companies relocating their production sites, but this has been ongoing for many years and, as other countries are seen as more reliable and secure, is likely to continue. Although the 2021 numbers are slightly skewed by COVID induced factory closures the gradual shift in location of footwear production by the two largest players is an example of how production locations have shifted over time, but globalisation remains.

Bob Dylan may have been prescient in his 1964 single, however the extent to which they ‘are a changin’ is likely not to be as dramatic as many have predicted but more of an increase in a trend that has been gradually underway for almost a decade.

1st July 2022
Read time : 7  mins

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Data source (unless otherwise stated): Bloomberg
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