Supply Chain Resilience

In the United Kingdom eggs are in short supply. Culling flocks due to avian flu has reduced upstream production. There are social and regulatory constraints on imports (more and more). Avian flu has also reduced stocks of broilers and egg laying hens on the continent (France and Netherlands (US too)). Constrained supply and higher production/transportation costs (often energy-related) have caused prices to increase by half since earlier this year, discombobulating demand in a manner that disrupts supply. It is complicated.

This is not, however, as bad as some were predicting last Spring. At that point the scope and scale of the European energy crisis plus drought projections plus the risk of a wider war prompted some plausible worst-case thinking of wide-spread cuts in core food production, processing, and freight movement. Brexit-related frictions were expected to amplify British consequences (as they have).

While far from a best case, over the last six months adaptations in European energy flows have achieved higher inventories and much more flexible (effective) velocity than I expected. Agricultural production has been uneven, more costly, and bulk transport often delayed, but European food resources are diverse and imports have been available to fill gaps. Freight players and processors have — so far — demonstrated considerable agility. Volumes have been sufficient to fulfill European food demand in the vast majority of places for the vast majority of products, the vast majority of the time.

As usual, this success has many sources. But demand pull and open flows have been fundamental. If these two factors had not been available or more seriously constrained, other sources could not have delivered the energy and food needed by 700 million plus Europeans. Spending on energy has soared (here and here and here and here). EU household utility costs are up almost 40 percent compared to decade-plus averages. In October the EU-wide inflation rate for food was over 17 percent (core inflation was just under 6 percent). Through September 2022 LNG imports to the EU already equaled more than the previous full-year record in 2019. During the first half of 2022 total EU food imports increased by one-third. Increased pull has motivated increased push.

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In December 2016 I participated in a global consultation on mass care in case of catastrophe — or at least near-catastrophes. The consultation was hosted in Berlin and focused on food flows. One of the principal discoveries was wide-spread lack of understanding related to midstream aspects of the food supply chain. Expertise was readily available for upstream food production, imports, and exports. There was also considerable shared familiarity with consumer-facing retail. But flows in-between were often a mystery.

Nonetheless, after the Berlin consultation I wrote my German hosts, “Given the structure of European food flows and the character of your risk vectors, the only catastrophic potential I recognize is the intentional targeted destruction of war.” This was not a prediction. It was, in fact, supposed to be reassuring.

In February 2019 there was a loosely related Copenhagen consultation on post-Brexit food flows for (mostly) Northern Europe. The lack of midstream awareness persisted, but there was much more sensitivity to how regulatory constraints (e.g., customs processes) can create physical chokepoints. One of our Dutch colleagues noted, “given volumes required, very marginal constraints on flow can have enormous market consequences for volume, velocity and price, spontaneously generating unwanted chokepoints.”

Late this Spring some of the same folks and many new colleagues gathered around Zoom screens to think through European food flows for the soon to arrive war-torn winter. Despite (or perhaps because of) the earlier work, there was considerable anxiety. But by late September when we gathered face-to-face there was much more confidence. Our Dutch colleague was now hosting. His closing remarks included, “perhaps we now better understand the limitations of our understanding and share a deeper appreciation for the ‘invisible hand’ of market pricing to prioritize what is really needed.”

It remains a hypothesis requiring more testing — I can still imagine proving the null hypothesis. We are still a long ways from a proven theory. But there is accumulating evidence for a principle of good practice that gives priority to facilitating pull.

[Update Below] On Wednesday the G20 Summit in Indonesia concluded with a communique that includes:

Most members strongly condemned the war in Ukraine and stressed it is causing immense human suffering and exacerbating existing fragilities in the global economy – constraining growth, increasing inflation, disrupting supply chains, heightening energy and food insecurity, and elevating financial stability risks. 

On Thursday the Black Sea Initiative that facilitates food flows from three of Ukraine’s ports was extended for 120 days. (More and more and see summary far below.)

Bali and at the Black Sea are linked, more directly than you might think.

Ukraine is typically the source for a significant portion of global food flows — especially corn, wheat, and sunflower oil. Ukraine’s food flows have been disrupted by Russia’s invasion. Early in the war Russian naval attacks — and anticipated amphibious operations — trapped ships in several ports, damaged warehouses, docks, loading facilities, and vessels, and excluded commercial operations in the northwest Black Sea, north of the Danube Delta. This blog did not anticipate any of Ukraine’s ports being reopened until hostilities concluded.

On July 27 Turkey and the United Nations brokered a temporary deal. I did not expect the agreement to stick. But it has — so far. By mid-August a slow flow of foodstuffs had restarted. Several ports remain closed. Sources and channels are profoundly constrained. But according to the United Nations, “As of 17 November, the total tonnage of grain and other foodstuffs exported from the three Ukrainian ports is 11,186,228 million metric tons. A total of 941 voyages (470 inbound and 471 outbound) have been enabled so far.” This flow has been fundamental to sufficient global volumes and some very rough semblance of affordability.

Food security is an acute concern in the Horn of Africa, across the straits in Yemen, all along the Sahel, and in many other places as a result of local crop failures and/or inability to pay in dollars (more and more). Food security is a core long-term strategy for several nations, among them the People’s Republic of China.

S&P Global recently wrote, “In recent years, China’s astounding growth in commodity consumption has outpaced its domestic supplies, compelling the government to import food commodities in large volumes. The Xi administration acknowledges the dire need to raise agricultural imports to satisfy domestic demand. But all that dependency on imports is leaving China vulnerable in its quest to become a superpower… China has been importing corn primarily from the US and Ukraine. However, supply from these origins have been uncertain due to geopolitical tensions.”

This is not where Xi wants to be. So, Xi was ready to agree when the G20 draft communique offered:

We support the international efforts to keep food supply chains functioning under challenging circumstances. We are committed to addressing food insecurity by ensuring accessibility, affordability, and sustainability of food and food products for those in needs, particularly in developing countries and least developed countries. We reiterate our support for open, transparent, inclusive, predictable, and non-discriminatory, rules-based agricultural trade based on WTO rules. We highlight the importance of enhancing market predictability, minimizing distortions, increasing business confidence, and allowing agriculture and food trade to flow smoothly. We reaffirm the need to update global agricultural food trade rules and to facilitate trade in agricultural and food products, as well as the importance of not imposing export prohibitions or restrictions on food and fertilizers in a manner inconsistent with relevant WTO provisions. We are committed to sustained supply, in part based on local food sources, as well as diversified production of food and fertilizers to support the most vulnerable from the disruptions in food trade supply chain. We will avoid adversely impacting food security deliberately. We commit to facilitate humanitarian supplies for ensuring access to food in emergency situations and call on UN Member States and all relevant stakeholders with available resources to provide in-kind donations and resources to support countries most affected by the food crisis, as required and based on assessed needs by governments of affected countries. We continue to support the carve out of humanitarian activities from sanctions and call on all nations to support this aim, including through current efforts at the UN. We will continue to closely monitor the state of global food security and nutrition.

While at the G20, President Xi said that China, “resolutely opposes attempts to politicize food and energy issues or use them as tools and weapons.” (More and more)

Following release of the surprisingly strong Bali declaration, one insider was quoted, “The Indonesians were smart. They started on something everyone could agree on, which was food security, and then built on that…” If food security is fundamental, there is every motivation to acknowledge what is happening to Ukraine’s grain and support continued flows. After several days of negotiations, it was clear to almost everyone — even the Russian Foreign Minister at Bali — where the G20 would land on Wednesday. This was instrumental to deciding where Turkey, the United Nations, Russia, and Ukraine would land on Thursday.

Supply Chain Resilience is a policy, strategy, and practice to maximize continued flows of demand and supply under severe duress. Supply Chain Resilience focuses on natural, accidental, and intentional disruption of flows. Intentional government action is a recurring source of various impediments ranging from delivery curfews to weight restrictions to public health interventions to bombing port facilities. Government actions usually have a purpose only indirectly related to supply chains — and the flow impediments caused by these intentional acts are often unintended.

Our settings are seldom as dramatic as Bali and the Black Sea, but Supply Chain Resilience often involves unveiling heretofore hidden connections between flows and policy. Reducing impediments and releasing flows often requires resolving heretofore hidden conflicts between policies. Supply Chain Resilience often depends on key decision-makers (both private and public) recognizing that flows of water, food, fuel, pharmaceuticals, and other critical freight are priorities that should not be unintentionally constrained — especially in a crisis.

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Following is an infographic developed by S&P Global and published on November 16.

November 24 Update: S&P Global reports, “The first shipment of Brazilian corn has started its voyage to Guangzhou, China after MV Star Iris, laden with 67,000 mt of corn, sailed from the Brazilian port of Santos at about 5 pm local time Nov. 23… Currently, China imports corn from the US and Ukraine to meet its domestic demand on top of its local production. China’s long-awaited participation in the Brazilian corn market is expected to shift global trade flows for corn…”

November 29 Update: S&P Global reports, “Corn buyers in Europe are growing concerned that their competitively priced supplies from Brazil will dry up as China begins to buy from there too.”

[Update Below] Over the last year, inbound maritime flows to the United States have slowed and dispersed (see chart below). This adaptation seems to be accelerating in the current quarter.

Recently declining demand for imports is behind the slowdown (see second chart below). The dispersion is part of a long-term trend. Demand-pull is usually fickle. Supply-push is inclined to be stubborn.

According to S&P Global, even as West Coast ports have experienced declining volumes, “South Carolina Ports handled 256,879 TEU during October… up 9% against the year. Loaded imports came to 121,305 TEU, up just under 13% on the year. October was the third busiest month in the port’s history. Elsewhere, the Port of New York/New Jersey moved 842,219 containers in September, over 130,000 more than the Port of Los Angeles during the same month.” (More and more.)

Dispersion arguably began in 2016 when new and larger locks allowed for passage of much bigger container ships to and from Asia through the Panama Canal. Pandemic pressures have accelerated use of alternatives to the Ports of Los Angeles and Long Beach (pre-pandemic it was typical for more than 40 percent of US container imports to be received at LA/LB). Intense congestion at LA/LB encouraged diversion of flow to ports other than San Pedro Bay. The ongoing threat of labor action at all US West Coast ports has reinforced this choice. A possible US rail strike would quickly cause congestion at just about every US container port, but West Coast inbound is especially dependent on long-distance rail to distribute East Bound flows.

So… while it took awhile to find, schedule, and coordinate vessels, drayage, warehousing, and surface transportation, over the last year-plus many US importers have spread their risk. Now that congestion is gone, LA/LB can reassert its innate proximity advantage for East Asian sources. Once the risk of labor action is resolved, US West Coast ports will reclaim some proportion of total flows. But the newly expanded US Gulf and East Coast channels will not be abandoned. They also have an innate comparative advantage in their proximity to many million US consumers.

[Soon to come: US Outbound Flows… especially via the Mississippi River]

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November 22 Update: Bloomberg reports: “Ports on the US West Coast could permanently lose as much as 10% of the seaborne cargo that has been diverted to the Atlantic coast amid logistics bottlenecks, regulatory headwinds and labor uncertainty.”

JIT is taking plenty of punches. At recent conferences I have heard speakers accuse “Just in Time” of causing shortages of canned soup, diesel fuel, and baby formula.

A recent survey of 400 business decisionmakers by SAP found that almost two-thirds are moving from “just in time” supply chains to “just in case” supply chains featuring more stored inventory. An SAP executive explained, “Over the last couple of decades, the ‘just in time’ approach traded resiliency for efficiency and lower costs, which in turn made the supply chain fragile. The pandemic and the snowball effect of related disruptions exposed this fragility, which has organizations refocused on resiliency.”

Listening to those who blame JIT, I mostly hear complaints that contemporary supply chains have gone too far in reducing inventories. We need more stock in various back rooms they claim. This angle is especially emphasized by those pushing the so-called “Just In Case” approach.

There is evidence for reduced inventories. According to US Census Bureau surveys (see chart below) prior to 2002 the ratio of retail inventory to sales was usually above 1.6 to one. Between 2002 and 2008 the ratio declined to about 1.5. After an inventory surge — also-known-as demand destruction — early in the Great Recession, the ratio fell below 1.4 before recovering to about 1.5 for most of 2015-2019.

Clearly these aggregated data can obscure significant product-specific variations (and tell us next to nothing about upstream stocks). But if you perceive (as I do) that JIT has been an increasingly common characteristic (aspiration) of contemporary supply chains, these data suggest that for the last two decades JIT has been roughly predisposed toward a 1.5 to 1.0 retail inventory to sales ratio. In other words, for every three units expected to be consumed there is a well-demonstrated tendency for two more units to be on the shelf or in the “back room” (and more are supposed to regularly arrive).

Not enough? Too much? If not enough, how much more should be stored just-in-case? Just in case of what? A sudden demand for one-fifth more than ever before (as some products experienced in March 2020). Losing one-fifth of production capacity (as with refining capacity between 2019 and 2021). A weeks-long loss of Mississippi River barge flows or Suez Canal container flows or a long-term rail strike or… name your threat. We have also seen that increased inventories increase financial and operational vulnerabilities in case of lost demand… as many US retailers have recently learned.

Just-In-Time is not — should not be — an inventory minimization strategy. That is a misleading goal and risky measure. JIT inventory management is one element in a whole-system process to better calibrate supply with demand. JIT is part of a flow optimization strategy — involving production, procurement, distribution, inventory, sales, consumption, and more — to better ensure delivery of what is needed, where it is needed, when it is needed, at a price that consumers can afford, and at a cost consistent with sustainable capacity.

The interplay of these variables can be treacherous. Failure to deliver what is needed when and where it is needed suppresses potential financial outcomes — and opens opportunities for competitors. Consistent failure to deliver what is needed will threaten the survival of the enterprise. Depending on the product, failure to deliver what is needed can threaten lives. Regularly delivering more than is needed wastes resources, increases overall costs, reduces potential financial margins, and diverts constrained assets — human, financial, operational, and more — that could be used to more effectively fulfill higher priority needs.

It is wasteful — and in many cases, practically impossible — to establish buffer stocks sufficient to fulfill high volume, high velocity demand in the aftermath of worst-case events (more). Blaming insufficient buffer stocks for pandemic-related supply chain challenges is analogous to blaming too few dining room chairs for problems in the kitchen (or grocery store or garden) or the arrival of sixty unexpected guests. The prescription is not to abandon JIT, but to ensure that whole-system planning and development deploy JIT disciplines to mitigate worst case risk. How this is done depends a great deal on the nature of each product and patterns of demand. There are, though, three strategic factors that — so far — I have found to be universally applicable.

Diversity of players and places across demand and supply networks enhances structural resilience. Avoid single points-of-failure. Instead of concentrating production or distribution or other throughputs in one place, invest in portfolios of critical capacity (more and more). Control related marginal costs through active management including strategic specifications, standardization, and interchangeability.

Distance is directly relevant to potential costs and time. Capacity closer to dense demand can mitigate possible delays and enhance supply velocity. But diversification still applies. Having all our eggs in any single henhouse (seismic zone or hurricane alley) amplifies the potential threat of the most unlikely fox.

Demand matters most. Too many supply chain decisionmakers watched demand crash between March and May 2020 and apparently could not see around the corner. Demand shifted dramatically, but did not disappear (see second chart below). The most successful firms understood their consumers (and suppliers) well enough to adapt to these shifts (and ongoing volatility). In many cases inventory ratios were suppressed by accelerated demand and higher sales. This is a happy problem.

Diversification of supply chain capacity will almost always involve marginal costs compared with maximized concentration. Proximity to diverse demand clusters will involve variable costs and some increased marginal costs related to labor rates, real estate, and other local conditions. Deep understanding of and creative engagement with demand emerges from sustained investments.

Non-resilience is also costly. In 2020 research by the McKinsey Global Institute found:

A single prolonged disruption can destroy half—or almost all—of a company’s yearly profits, depending on the industry. Based on those results and the probability of actual occurrences, we estimate that, on average, companies can expect disruptions to erase almost 45 percent of one year’s profits over the course of a decade. These are not distant future risks; they are current and ongoing patterns. On top of those losses comes the additional cost of rebuilding damaged physical assets, not to mention the risk of permanently losing market share to competitors that are able to sustain operations, recover faster, or seize on a crisis to innovate successfully.

Just In Time is a rational tactic that for seventy plus years has reduced wasted time and physical resources even as it has facilitated speedy, affordable fulfillment. As with any tactic JIT can be deployed strategically or stupidly. Stupid is as stupid does — too often the result of myopic management measures. Smart strategy requires an expansive sense of space, time, and behaviors. Trite but true (even if Sun-Tzu did not say it): Strategy without tactics is the slowest route to victory, tactics without strategy is the noise before defeat.

[Update Below] S&P Global has, once again, delivered a helpful visualization of the intended (likely? possible?) outcomes of G7 price caps on Russian oil and refined products (see below). S&Ps analysis and commentary highlights ambiguities, especially for shipping markets and related insurers. In any case, this is a further deployment of financial markets and mechanisms to make it more difficult for Russia to continue its war against Ukraine. Since the February 24 invasion, the G7 nations — Canada, France, Germany, Italy, Japan, United Kingdom, and United States (and EU) — have closely coordinated sanctions on Russia. According to an October 11 G7 statement, “We have imposed and will continue to impose further economic costs on Russia, including on individuals and entities – inside and outside of Russia – providing political or economic support for Russia’s illegal attempts to change the status of Ukrainian territory.” These actions are part punishment, part constraint, part setting the stage for future negotiations. Echoing Clausewitz (title’s German phrase ), this too is a “continuation of policy by other means” — perhaps two steps removed from direct violence. (More and more and more)

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November 29 Update: The Financial Times delivers a very helpful “Big Read” on prospects for the price cap on Russian oil, with considerable attention to implications for network structures. S&P offers a skeptical angle on the entire effort.