Supply Chain Resilience

In many places (where I live, for example) covid-related hospitalizations are declining. But this is not the case everywhere and big picture trends are concerning. Patterns outlined last week have persisted.

While the US demand curve has declined from peak-Delta, it has remained quite high and in some places is beginning to once-again bend upward. Please see the chart below for results as of November 12 for seven nations.

This last week Germany confirmed more new covid infections than ever before (more). Resurgent numbers in Italy have prompted discussion of another Christmas slow-down or shutdown (and not just in Italy). The Netherlands is slowing-down now in an effort to head-off a sharper stop later.

The persistent plateau (see below) in the UK seems to be easing, but the churn across the channel is concerning. In the United States it very much depends where you live and what you and your neighbors have decided about vaccinations. Counties in New Mexico and Colorado with low vaccination rates are the current hotspots. But even in highly vaccinated Vermont, Halloween parties are allegedly to blame for an outbreak at St. Michael’s College.

About three weeks ago I advised that, despite improving trends, there was still good cause to minimize travel, avoid interior crowds, and cover our nose and mouth when we cannot avoid sharing interior crowds. For the record, I just spent most of a week in Dallas, where I met inside with many others, and very seldom wore a mask in those rooms. I understand everyone was vaccinated, the room was well-ventilated, and it was not really crowded. But we were certainly not always six feet apart. Only two or three consistently wore masks. Good for them. I am a risk-aware hypocrite. There are too many of us and too few of them.

In the week prior to Halloween (before Amazon with Apple dramatically highlighted supply chain constraints), Tom Keene on Bloomberg Surveillance offered the best concise summary of supply chain realities that I have heard. He said, “It’s microeconomics and there’s ambiguity and there’s give-and-take and, frankly, there is an unknown and we are learning as we go in a natural disaster.”  (Please see below, start listening at about the 59:52 mark.)

Over the last several months I have written many more words. But TK seemed to spontaneously summarize what really matters.

Still, many want more detail than Mr. Keene provided, but more clearly and concisely than is typical of my method. So, as some of you have requested, here’s one more try.

Early in the pandemic US consumer demand fell hard and fast by about one-fifth. Then between May 2020 and about March 2021 overall consumption recovered. Since this March overall demand has increased by another half-trillion dollars per month.  This demand is usually being fulfilled.

But where consumers once purchased lots of services — like travel, entertainment, and eating out — over the last 18 months consumers have focused on a lot more stuff, even twice as much stuff (more).

Producing and delivering this much extra stuff this quickly would have complicated and congested flows in the best of all possible worlds.  But trying to supply this surge and shift during a pandemic has been extra tough.  Constraints on time and space intended to mitigate disease transmission have reduced production and distribution capacity. Disease penetration has been even more disruptive. Shifting upstream capacities created proliferating and unpredicted downstream gyrations 

Persisting supply chain friction has amplified human fatigue and frustration (and even fear) that has further constrained system capacity (e.g., workforce retirements, resignations, reimagining careers, non-participation, and more). Friday Amazon’s CFO explained, “For the foreseeable future, our capacity constraint is actually labor, which is new and not welcome.”

Supply chain constraints are promiscuous and breed additional constraints. Efforts to mitigate this proliferation of constraints (e.g. port congestion) have been complicated by issues of distance between supply and demand and over-concentration of channels (e.g. ocean shipping and port capacity).

These aggregated frictions (and complex feedback signals) are now constraining some fundamental flows, from food to fancy high-tech phones. Which products or categories are most at risk at this point seems to me more and more a betting proposition than anything else. Chop and wind in every channel are sufficient to threaten just about everything on offer. It is a mess. As previously outlined, I do not perceive the mess as an existential threat (except to some smaller retailers). But it is certainly an equal opportunity mess with the potential to seriously complicate economic outcomes for an extended period.

As consumers have less cash to spend and the proportion spent on services increases, overall pull is very slowly beginning to even out (more). Over-time (probably by March-April 2022, barring a more insidious virus or similar) this will result in noticeably improved equilibrium of demand and supply.  If and when volatility returns to something closer to pre-pandemic patterns is another Vegas bet.

This increasingly frustrating experience reveals the dangers associated with over-concentration of supply networks, especially when amplified by distance, and the current lack of effective structures for the exploration and exploitation of enlightened self-interest in managing the global ecosystem of demand and supply.

Here are just a few of a recent flood of related headlines:

Port Gridlock Stretches Supply Lines Thin (Bloomberg)

America is Running Out of Everything (The Atlantic)

Global Supply Chain Problems Escalate (Wall Street Journal)

The Supply Chain Crisis and US Ports (The Financial Times)

The Global Supply Chain Nightmare is about to get Worse (CNN)

America’s Broken Supply Chain (Washington Post)

Grocery’s Biggest Players Seek to Reassure on Holiday Supply Chains (Grocery Business)

Despite the intense attention, none of this is new. Supply chain friction has been accumulating for many months — as well reported by each of the news organizations linked above. But the prospect of Santa’s supply chain failing for this Christmas has evidently become a source of civilizational angst. Accordingly last week the White House gave supply chains some sustained attention (and here and here).

Beyond this year’s fads (whether for children or not), what is really happening with our demand and supply networks?

On October 15 the US government reported August sales of $1.68 trillion (“the combined value of distributive trade sales and manufacturers’ shipments”), compared to 2020 August sales of $1.44 trillion and 2019 August sales of $1.50 trillion. Despite this strong spending, the US savings rate remains above nine percent, almost two percent higher than decade-long averages. US demand is strong and has the potential to stay strong for several more months.

Every product category tracked for the broadest sales indicator shows increases from August 2020, especially for food and beverages. The pandemic prompted significant growth in 2020 grocery sales. Just a bit above $72.5 billion in food and beverage sales for August of last year was more than $5 billion better than 2019. August 2021 sales beat 2020 by another $4 billion (now helped by expanding restaurant sales). There are currently spot stock-outs of some grocery items. Given the context, that should not surprise.

Stock-outs are, at least in my mind, different than shortages. We are producing and importing more than ever before. American (and other) consumers apparently want even more. Inventories are often lean or even anorexic. But is it more helpful to say supply is short or demand is strong? There is a disequilibrium of supply and demand. What helps us better perceive and potentially deal with the causes?

The delayed discharge of containers at the Ports of Los Angeles and Long Beach has received generous attention. There are dramatically obvious problems with dock density, operating hours, and overall port congestion. Still… in 2018 the Port of Los Angeles moved a record-breaking 9.45 million containers. In 2019, with trade-tensions constraining flow, this dropped to 9.33 million containers. The 2020 pandemic contributed to a further drop to 9.21 million containers (mostly due to loss of flow in February to May). Through August 2021, the port has moved 7.27 million containers — thirty percent more than by August 2020. The port of LA looks very likely to break its 2018 container record.

More broadly — and for better or worse — the United States is well on its way to importing more volume in 2021 than ever before. According to S&P Global:

Imports to the U.S. by volume grew 5.1% year over year in September, continuing the logistics surge that has caused congestion in ports across the country. This was slower than in previous months but 17.4% higher than September 2019. The comparison with 2020 is now exceptional for a different reason — this time, it is against a post-pandemic surge rather than lockdown-related lows. September also brings the growth rate for the third quarter to 10.2% year over year, or 15.3% compared with the third quarter of 2019. There was an average of 95,341 twenty-foot equivalent units per day in the third quarter. If imports remain at this level, the fourth quarter is expected to show a growth rate of 4.7% year over year, exceeding the record-breaking 2020 holiday season.

Demand is, well… demanding. To fulfill this demand, many flows moving toward demand have increased one-fifth to one-third above pre-pandemic baselines. This sudden and substantial increase creates problems. The number of docks with cranes has not increased nor has the number of trucks. Even comparatively rapid expansion of warehouse square footage has not increased as much as demand. There are also challenges hiring truckers and warehouse workers and many others on which efficient flows depend. But flow volume is still higher, not lower than 2019.

While demand is pulling hard and flow is pushing hard, what about upstream production capacity? As with flow, unusually swift shifts in demand have created several problems. The sudden slow-down in demand for older-version automotive semiconductors in the first half of 2020 has complicated serving increased demand ever since. The increased demand for cutting edge semiconductors in a wide array of high-performance electronic tools and gadgets has been tough to fulfill. There are other examples. There are serious constraints to growth in specific product categories.

But overall manufacturing production has soared in response to strong demand. In August 2021 (in the midst of the Delta variant’s worst effects) 18 of the G20 nations had increased manufacturing production over the same month in 2020. US manufacturing production remains above where it has been most of this century (see related chart below). There are forward going concerns about cost and availability of energy, especially in Europe and China. Disease penetration and/or disease mitigation measures have reduced productivity in some cases (examples here and here and here). Unreliable flow velocity can upset production calendars, even when sufficient volumes are available. In a system-of-systems distress in one place can complicate every place.

Nonetheless, unusually high demand is usually being fulfilled. Demand has effectively pulled more manufacturing forward. More manufactured products are being pushed toward demand. Preexisting capacity — for both production and movement — is not infinitely flexible. But in many cases, more than one-fifth more is being made and moved than in late 2019. In some cases, additional capacity is being developed.

Deficit and disequilibrium are different. Today’s most challenging supply chain problems are caused by many millions of consumers wanting more than ever before. Abundant demand has generated a flood of supply. This flood has overwhelmed some factory floors, ports, and preexisting freight capacity. A flood creates problems, but it should not be confused with drought.

Coda (October 20)

Derek Thompson concludes America is Running Out of Everything with, “The best solution to the Everything Shortage is to have a policy to make more of just about everything.” Given human desire and capitalist culture, his prescription is well-matched to context. But another possible angle is to want — or at least consume — less.  This too would facilitate enhanced equilibrium of supply with demand… and could even craft a more sustainable give and take between the personal and planetary.

Some of our problems begin with the label: supply chain. Chains are linked, which is helpful. But chains do not flow, rather they tend to tangle. For too many, mental images spawned by the term (supply chain) reinforce perceptions of linear links connecting origins with destinations. Replace weak links or untangle twisted links and problems are solved. It has not been that simple for at least a half-century (maybe never).

Wider understanding of demand and supply networks is also obscured by the wonderful work of Walmart, FedEx, UPS, Amazon and others in eliminating consumer-facing friction and related costs. Until recently it seemed so simple to track a package (often delivered with “free” shipping). If possible for a pair of shoes or books or dog food, why not several million computer chips?

Why can’t the Secretary of Commerce pull up on her smartphone (or at least on her secure laptop), a General Motors batch order of semiconductors and immediately see which fabrication plant or port or warehouse or cargo-carrier is causing the delay? As Secretary Raimondo explained on Friday, all she wants to do is solve the problem.

Demand and supply networks are not so simple. Network behaviors are especially susceptible to misaligned angles of perception. According to the economist Richard Sugden,

Most modern economic theory describes a world presided over by a government (not, significantly, by governments), and sees this world through the government’s eyes. The government is supposed to have the responsibility, the will and the power to restructure society in whatever way maximizes social welfare; like the US Cavalry in a good Western, the government stands ready to rush to the rescue whenever the market ‘fails’, and the economist’s job is to advise it on when and how to do so. Private individuals, in contrast, are credited with little or no ability to solve collective problems among themselves. This makes for a distorted view of some important economic and political issues.

Behind the clean lines of our tracking interfaces is a wickedly complex socio-technical system constantly pushing and pulling to calibrate high volume demand with right-velocity supply. Information is analyzed and financial transactions are dissected to move the most “units” at least cost to arrive at the right place at the right time to motivate more buying. Upstream from every very busy Fulfillment Center is a boiling, thrashing flood of flows cascading across space and time toward the wants and needs of 8 billion humans and all our related creatures and creations. The day-to-day creators and managers of this flood and flow are mostly “private individuals.”

High volume, high velocity demand and supply networks (and some low velocity too) are complex adaptive systems where a large number of independent, heterogeneous and (often) competitive agents interact dynamically (sometimes collaboratively) to shape flows and outcomes across the entire system through self-organization and self-similarity at multiple scales. Individual agents and the whole-system demonstrate adaptive behaviors that result in the emergence of functions and outcomes that transcend the capabilities of any individual agent or sub-system.

In my judgment this process of emergence has now created a global commons of demand and supply where the networks of information exchange, financial transaction, and physical movement are Common Pool Resources benefiting the vast majority of “supply chain” participants in most places most of the time.

In 2009 Elinor Ostrom, a great scholar of Common Pool Resources, was awarded the Nobel Prize for Economics. In her Prize Lecture, Ostrom highlights six recurring characteristics of effective problem-solving among stakeholders dealing with both public-goods and common pool resource challenges:

1. Communication is feasible with the full set of participants. When face-to-face communication is possible, participants use facial expressions, physical actions, and the way that words are expressed to judge the trustworthiness of the others involved.
2. Reputations of participants are known. Knowing the past history of other participants, who may not be personally known prior to interaction, increases the likelihood of cooperation.
3. High marginal per capita return (MPCR). When MPCR is high, each participant can know that their own contributions make a bigger difference than with low MPCR and that others are more likely to recognize this relationship.
4. Entry or exit capabilities. If participants can exit a situation at low cost, this gives them an opportunity not to be a sucker and others can recognize that cooperators may leave (and enter other situations) if their cooperation is not reciprocated.
5. Longer time horizon. Participants can anticipate that more could be earned through cooperation over a long time period versus a short time.
6. Agreed-upon sanctioning capabilities. While external sanctions or imposed sanctioning systems may reduce cooperation, when participants themselves agree to a sanctioning system they frequently do not need to use sanctions at a high volume and net benefits can be improved substantially.

Again and again, these are behaviors that supply chain stakeholders experience and demonstrate. As with most complex adaptive systems these behaviors are duplicated across very different scales of time and space: immediate and local to durable and global. These interactions are most often entirely private-private, occasionally facilitated by civic organizations such as associations or academic institutions. Governments can play a role, especially in convening and facilitating. But self-restraint is especially difficult for public sector players when crises unfold. Secretary Raimondo’s sense of urgency is not inappropriate. It is uncertain of best targets. It may also underestimate solution-paths already underway. (But the read-out of last week’s semiconductor consultation and a few quick conversations with participants suggests reality is not yet rejected and may even be, reluctantly, increasingly accepted.)

Current production capacity almost always reflects recent demand velocities. Sudden spikes in demand velocity are usually observed with considerable skepticism. Production capacity — especially for something as sophisticated as semiconductors — does not come cheap. No one wants to over-invest in a passing fad or soon-to-disappear legacy. But sustained effectual demand is an effective motivator.

The pandemic’s Great Interruption continues to disrupt current supply capacity for semiconductors even as it accelerates and diversifies demand. It has been clear for nearly one year that much of this demand is durable and worth accelerated investment in capacity expansion. These investments are being made (here and here and here and here). Will new supply sources close the gap by this Christmas? No. By New Years Day 2023? Maybe. Are there ways that current capacity could be further streamlined, rationalized, prioritized — something — to reduce the current gap? Yes. Many efforts are already underway.

Is there a helpful role for the public sector? Yes. But probably not by attempting a forensic analysis of a complex adaptive system and then developing an intervention strategy (please see Sugden supra). Flow mapping is something very different. Government fiscal and monetary policies have already amplified aspects of demand surge. These interventions are softening, so public sector help has already started. State and federal policies can probably nudge a bit more onshoring of production capacity. I don’t see many wise opportunities for expediting expansion of production capacity. Unwise opportunities are always available, but marginal or unlikely rewards do not justify certain significant risks.

If undertaken with skill, insight, and appropriate restraint, the public sector can play an important role convening and facilitating the six characteristics of effective problem-solving that Ostrom has highlighted. There is a rich literature of many more rigorously researched and confirmed attributes of stakeholder problem-solving. I wish Dr. Ostrom was still with us to advise. But there is plenty of expertise available, if asked.

Toward the close of her Nobel Prize lecture, Dr. Ostrom sets out an action orientation and a series of fundamental questions:

… humans have a more complex motivational structure and more capability to solve social dilemmas than posited in earlier rational-choice theory. Designing institutions to force (or nudge) entirely self-interested individuals to achieve better outcomes has been the major goal posited by policy analysts for governments to accomplish for much of the past half century. Extensive empirical research leads me to argue that instead, a core goal of public policy should be to facilitate the development of institutions that bring out the best in humans. We need to ask how diverse polycentric institutions help or hinder the innovativeness, learning, adapting, trustworthiness, levels of cooperation of participants, and the achievement of more effective, equitable, and sustainable outcomes at multiple scales.

The set of questions recently posed by the Department of Commerce implies that many supply chain stakeholders must be idiots or are too greedy or short-sighted or functionally incompetent or… something needing government guidance — to make choices consistent with their long-term self-interest and the public good. The questions imply that if the government receives honest answers, the government will be able to craft a rational solution. At least to me this reveals a Newtonian confidence poorly calibrated to a much more Quantum context. Continued private-private and private-public conversations can be very constructive. Please trash the hubris.

The foreground of our picture is crowded. Too much demand for too much stuff. Too few containers for too much stuff. Too many ships waiting for too few cranes. Too many containers for too few chassis’ (truck or rail). Too much throughput for too few workers.

Contemporary supply chains are organized around demand. Fulfilling demand is the mission, purpose, obsession — perhaps even graven idol — of global business. So, eyes widened and jaws gaped on September 6 when Morten Engelstoft, CEO of APM terminals, told the truth to The Financial Times, “We need lower [consumer demand] growth to give the supply chain time to catch up, or differently spread out growth. Over a long period of time, we will need to recover efficiency.” (More and more and more.)

The FT reminds us, “US imported goods in July were up 20 per cent over the previous year and 11.5 per cent over 2019 as consumers splashed out, with their spending supported by stimulus measures since the second half of last year.”

The problem is most obvious at the Ports of Los Angeles and Long Beach, together the largest-by-far maritime cargo complex in the United States. Last week a record-setting sixty-plus ships were lined up waiting to unload. (See the satellite picture below and more from the Washington Post.)

Typically it is not darkest just before dawn, but we can confidently claim that dock density is worst just before incremental improvement:

The US personal savings rate has fallen to 9.6 percent, down from 26.6 percent as recently as March. American consumers still have a bit more cash-on-hand than pre-pandemic (February 2020: 8.3 percent), but the sense of having money to burn is unlikely to return.

On Friday (September 17) the LA-Long Beach ports announced they will facilitate more hours of truck access to retrieve and return containers. This is unlikely to increase the number of trucks, but it could increase velocity, almost certainly for truckers and trucks that arrive at off-peak-hours and maybe for the whole system if enough truckers decide to do so.

According to The Financial Times, the container construction industry, “is set to pump out a record 5.2m twenty-foot equivalent units (TEUs) this year, up two-thirds on 2020.”

With the usual shippers charging premium rates for tightly constrained capacity, alternative means and methods of moving cargo are beginning to fill some crucial gaps — for those able to pay. Non-traditional vessels are delivering to non-traditional ports that can move goods along less-crowded routes.

So, in the background of our current picture we may see dawn’s thin light rising to the east of crowded San Pedro Bay. There is finally some increased shipping capacity. There is incremental improvement in moving goods. But the current pile up is huge. Even if demand finally returns to something more sustainable, it will be months before something like 2019’s flow is experienced again.