Supply Chain Resilience

Every variant of SARS-CoV-2 has produced mild symptoms in most of those infected. By now many of us — perhaps most of us (who do not live in New Zealand or Tonga) — have been infected but have remained asymptomatic (or barely symptomatic) and don’t even recognize our encounter with covid. But for two to three percent of those infected, results have been much more difficult, even life-ending.

There is accumulating evidence that — so far — the earliest encounters with omicron produce modest morbidity — especially when people are vaccinated. Here (again) is the most recent study out of South Africa. Here are two just-released studies from the United Kingdom, one from the University of Edinburgh and a second from Imperial College (London). I cannot yet find original source material for an analysis just completed of omicron cases in Denmark, but here is a helpful overview of three of these four reports (including Denmark’s) in this morning’s Financial Times.

In most places for most people individual risk of omicron causing serious covid is no worse or less than previously. People who are vaccinated have reduced risk. People who are boosted have very low risk of experiencing serious disease.

But omicron is very contagious, the most contagious variant yet. Omicron has also demonstrated a rather amazing ability to re-infect those with prior immunity (natural or vaccinated). Even if the hospitalization rate for omicron is the same or a bit less than prior variants, omicron’s transmission rate could push the health care system over the edge. A two percent hospitalization rate for 300 million cases will cause six-times the hospitalizations of two percent for 50 million.

Which is just a long way of saying, epidemics are less about individual risk than population risk. I am well over sixty, but otherwise my individual risk profile for serious disease is modest. I wear a mask, keep my distance, and minimize circulation to protect others from me. Mass vaccination does have individual benefits, but mass vaccination is especially important to manage risks for the most vulnerable among us. I am — all of us are — potential hosts and mutation factories for viruses. We will continue thus until we have suppressed SARS-CoV-2 worldwide. In most cases, our personal risk to this virus is negligible. But to reduce the risk to the most vulnerable — and those who are called upon to care for the most vulnerable — I want to do what I can.

There are obviously epidemiological and ethical implications here. I also perceive supply chain implications. Supply capacity is almost always the outcome of expensive long-term investments… for example in clinical facilities, pharmaceutical innovation… manufacturing… distributing, extensive professional education, and much, much more. Certainly, we want to build-in buffers for variation in demand. But there is seldom an affordable, reasonable way to develop supply capacity for a sudden doubling or more of well-established large-scale demand. So, I want to do my part to reduce demand on an already stressed system.

Part of the current disequilibrium of supply with demand involves flow capacity from warehouses, distribution hubs, and fulfillment centers to retail and direct-to-demand. Omicron threatens to further constrain. But there is still time to avoid the very worst.

Early last week a friend confessed his large-scale grocery distribution enterprise is getting enough inbound volume, but can not always gin-up sufficient outbound velocity to fulfill the fastest retail turnovers. The problem, he said, started last Spring/Summer when he lost many of his most experienced selectors and drivers. He has not been able to hire fast enough to fill the gaps (in both numbers and skill). (See: Journal of Commerce, Transport Topics, CNBC, Bloomberg, Wall Street Journal, Lehigh Valley Live)

According to the Bureau of Labor Statistics, in November 2021 there were just over 1.5 million “warehousing and storage” employees. This compares with about 1.28 million in November 2019. That’s almost a fifteen percent increase. Problem is retail sales are up nearly twenty-three percent over the same two years. Plenty of toil, turmoil, and trouble is embedded in that eight percent gap, especially for places where the overall national rate is doubled or worse.

Friction is added to this already tight flow by various measures intended to mitigate transmission of SARS-CoV-2 among employees. No one wants an outbreak in their facility. But omicron’s behavior suggests that over the next six to twelve weeks there will be many outbreaks. Most workplaces will be unable to avoid outbreaks of this highly contagious version of the virus.

The Centers for Disease Control offers workplace recommendations. OSHA has developed and enforced related workplace regulations. State and local public health agencies typically have the strongest legal authorities for mitigation measures, including isolation and quarantine. The recommendations and regulations are conditional. What should be done depends on context, including the vaccination status of employees. This is empirically justified. It is also administratively very complicated, especially for large-scale enterprises with operations in many different jurisdictions.

Last week I was asked about the isolation and quarantine policies of food processors, distributors, and retailers. I did not know, so I asked seven market-leaders. I heard back from five. This very informal survey found that their policies reflect CDC recommendations (unless local officials are unusually insistent). While this reach-out found variation, this essentially means that workers with a confirmed case or contact with covid are typically off the job for ten days. With a negative test, this can be reduced to seven days (but the quick survey suggested this is atypical given lack of access to testing). Two respondents suggest non-compliance is widespread due to both ignorance and intention.  But especially in union-organized work-forces, isolation and quarantines have and do impact capacity and through-put.

I was asked this question by smart, well-informed people who are aware of both the best science and official policy on workplace good practices. But as we talked, they disagreed. This is not surprising. In many ways — given our risk environment — it is realistic, even encouraging. But this realistic uncertainty is resulting in industry practices that are more rigorous than recommended by the most current CDC advisories and OSHA regulations. Until someone points me to more authoritative texts, here are the two sources that I have found especially relevant: CDC’s Interim Public Health Recommendations for Fully Vaccinated People and OSHA’s Guidance on Mitigating and Preventing the Spread of COVID-19 in the Workplace. (The CDC text was updated in October and November.)

Here is what I perceive the CDC is telling work-place managers. These are my words, not official language. The words below represent my understanding of the written text as interpreted by my management-mind into operational guidance. I am a one-time CEO, not a lawyer or epidemiologist. I am interested in safely preserving and enhancing flow. Lawyers and epidemiologists have different roles.

After exposure to a confirmed case of covid, employees should be tested within five to seven days.

Fully vaccinated employees who come in contact with a confirmed case of covid but are asymptomatic can continue working but should wear a mask when in close proximity to others.

Unvaccinated employees who come in contact with a confirmed case of covid should isolate at home for ten days or until receiving a negative test.

Employees (vaccinated or not) presenting with covid symptoms should be tested before continuing to work.

With a negative test, employees can continue working.

If an employee tests positive for covid s/he should isolate at home for ten days or until receiving a negative test.

There are exceptions, caveats, and a range of special considerations, but I understand these six statements to accurately summarize current guidance.

Some obvious implications, but just to be explicit: Vaccinated employees have greater flexibility than non-vaccinated. The more vaccination, the better potential for flow. If I have accurately understood the CDC and OSHA texts, the standard-operating-procedures reported by the five big food suppliers do not reflect the enhanced flexibility already recommended for vaccinated employees. Rapid testing can also reduce absenteeism and related friction.

But here’s the rub, based on where omicron is likely to take us between now and March, even vaccinated employees will be increasingly infected and re-infected. Many of our current work-place mitigation measures are intended to contain transmission. With omicron this intention seems to be overcome-by-events. There is a real risk of accumulated mild symptoms and positive tests decimating flow potential for food, pharmaceuticals, medical goods, and a wide range of freight. Given the contagious speed of omicron and current policies, too many nodes and links are at risk of too many ten day purges.

By the end of this week the rapidly worsening situation in Denmark and the United Kingdom may give us epidemiological confidence in omicron’s severity (aka virulence). If these real-world tests confirm that vaccinations (especially with boosters) prevent serious disease, it is probably time to allow vaccinated-boosted workers (even with a positive test) to continue working with other mitigation measures in place. I do not suggest this is an easy or obvious decision. But failing to proactively facilitate essential flows will also have profound human consequences.

Most news coverage of Wednesday’s November retail sales report included something like this:

Retail sales rose modestly at the start of the holiday season, as shoppers faced rising inflation and supply shortages, and some snapped up gifts earlier. Sales at U.S. retail stores, online sellers, and restaurants rose by a seasonally-adjusted 0.3% in November from the previous month, the Commerce Department said Wednesday. That was smaller than last month’s increase in consumer prices, and a slowdown from October’s robust 1.8% sales increase. [Wall Street Journal]

Inflation and supply shortages are not exactly blamed, but the implication — repeated again and again — is that consumers are being suppressed by higher prices and lack of supply. There is, I agree, cause to believe that Americans would have purchased even more if prices had been lower and inventories had been higher. But, at least for this supply chain guy, that angle obscures the bigger story — captured in the first chart below.

An equally valid headline would be: Americans continue buying more than ever before.

This persistent level of unprecedented demand, even as pandemic savings is being spent-off (see second chart below), is the principal cause of recent retail price increases and supply chain challenges. How long can this level of demand continue? At the end of the third quarter US household debt payments were still below historic averages (see third chart below). I bet that upward curve in debt payments has continued in the current quarter. As the saving rate declines and debt payments increase, actual retail sales will return to something much closer to pre-pandemic normal.

Contemporary high volume, high velocity supply chains organize around demand. The United States combines significant population with well above-average wealth. US demand motivates supply, both foreign and domestic.

Since December 2020 suppliers of US demand have been highly motivated. For example since last Christmas, US retail sales have increased from about $485 billion per month to over $565 billion (retail sales for November 2021 will be released later this week). This roughly 15 percent increase is the sharpest surge in the history of the measure.

In some product categories this increase has been razor sharp. Due to pandemic constraints, demand for many services (e.g., travel and eating-out) experienced stark declines. This reduced spending resulted in a personal saving rate of over 33 percent in April 2020, remaining significantly elevated until quite recently. With more cash on hand and pandemic constraints persisting, over the last twelve months US demand shifted from less tangible to more tangible products. For example, between February 2020 and October 2021, durable good purchases increased by nearly one-quarter.

Supplying this sort of swift increase and swerve in demand is not easy. Flows have experienced considerable friction and volatility. For example, according to the Logistics Managers’ Index, “In October, upstream respondents reported rates of growth 10.3 points higher than their downstream respondents. In November this flipped, and upstream respondents reported inventory growth was 10.9 points lower than downstream respondents. The shortages of retail goods this holiday season have not been as severe as they were predicted to be. This seems to have been largely achieved by firms spending heavily on warehousing and transportation to get goods downstream.”

Supply capacity for both warehousing and transportation is limited. There was certainly not a quarter-more capacity of either idly standing by (including, of course, each function’s work-force). As a result, prices for available warehousing and transportation have increased. Demand is mostly being fulfilled, but at higher costs… and with some delays and, almost certainly, with some shedding of low-margin places and people.

Given the competitive context, not all additional costs are being passed along. Several of the largest retailers are attempting to minimize price increases in an effort to protect and expand market share. But some increased costs are percolating through to retail prices, especially for fuel and food. From November 2020 to November 2021 the Consumer Price Index increased 6.8 percent, the largest increase since 1982. Part of this elevation reflects a one-third increase in the 2020-2021 energy index (2020 gasoline prices were unusually low). Year-Over-Year food prices in November were up 6.4 percent. In November apparel showed a YOY increase of 5.0 percent.

Financial and operational data confirm the challenge involved in preexisting supply matching surging demand (especially when complicated by pandemic-related problems). But flow has adapted and push is mostly fulfilling pull in most places for most Americans… who even now have slightly more money than usual to express their demand. Some have even begun to worry about excess inventories becoming a problem in the New Year.

Demand exploded. Flow adapted. To what extent has supply capacity changed?

My best answer is: I don’t know. The data with which I am familiar only offer tantalizing inferences. But my working hypothesis is: not much. At least not yet — and for most product categories significant capacity expansion strikes me as unlikely.

Not yet because the demand surge was so sudden. New warehouses do not materialize out of desert air. Because of structural changes in how high volume, high velocity flows are fulfilled, I expect a continued expansion in US warehouse capacity. But this is mostly due to swerving demand instead of surging demand. I do not expect recent increases in demand to survive far into 2022. I do expect the swerve, in terms of how and where demand is expressed, to persist.

Unlikely because transportation capacity is time-consuming and expensive to increase. Most maritime and air cargo players seem to perceive (accurately, I think) that the 2021 surge in US demand is unsustainable. Investments being made in future capacity are more about enhanced efficiency to serve incremental growth, rather than pedal-to-the-metal to close gaps in current flows. The trucking industry is working hard to avoid real reductions in capacity compared to increasing demand. The slow-down in demand that I expect will more closely match current trucking capacity (even as the demand slow-down could kill-off some trucking firms that have over-extended to serve recent demand surges).

Some data and analyses suggest that recent increases in energy prices reflect diminishing fossil-fuels capacity and very real costs involved in the treacherous transition to a post-fossil fuels future. So, there is both loss and gain in energy supply capacity and the net result will probably not be well-assured until the end of this decade (at least).

There are exceptions to my mostly-more-of-the-same prognosis. Significant new investments are being made in production capacity for semiconductors. As with warehouses, this expanded capacity reflects a fundamental shift in how global consumers behave and what they expect from the products they purchase. These behaviors and expectations justify the sort of large, long-term investments needed to expand this expensive supply capacity.

As plenty of other posts to this blog suggest, we are not yet operating in a post-pandemic context. But when such a day does come, it seems to me demand will look much more like 2019 than most of 2021. Our current flow capacity is much better suited for 2019 than 2021. Far upstream there are plenty of changes underway, but most of these are right-sized to a scope of demand that is much more pre-pandemic than mid-pandemic. So, as the flood of demand subsides, so will the turbidity we have seen in flows and that strange sucking (or is it squeezing?) sound from farther upstream.

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I will readily confess that this is the same argument I have tried to make for many months. There is not much evidence that this supply chain guy has persuaded many. Maybe a big-time financial analyst will do better. Please listen to at least the first 90 seconds of Michael Collins (PGIM) explain. Sound familiar?

https://www.bloomberg.com/news/videos/2021-12-13/totally-flat-yield-curve-is-already-priced-in-pgim-video

December 18 Addendum: Another very similar explanation courtesy of the Wall Street Journal and Phil Levy, Chief Economist at Flexport.

January 11 Addendum: Yet another demand-focused distribution-strained explanation from Karl W. Smith with Bloomberg.

Okay, I will stop tracking these convergent analyses… I recognize this is a bit of a defensive reaction on my part. But c’mon folks.

While covid case counts skyrocket in South Africa, clinicians note that — so far — omicron seems even less likely than prior variants to cause severe morbidity; even while the most watched measure of mortality in South Africa has doubled coincident with the spread of omicron.