SUPPLY CHAIN REACTION
I, Pencil is an essay published in 1958 detailing the complex supply chains involved in creating an ordinarily lead pencil. It involves the labor and capital inputs of hundreds of people from multiple countries, each with their own language and currency. Not a single person is responsible for the thousands of decisions that go into the pencil’s creation, but rather it is a product of a globalized supply chain.
Since then, supply chains have grown exponentially more complex as advancements in transportation and finance have squeezed costs, reduced delays, and led to just-in-time inventory to deliver what is needed when needed. These vast supply chains span the globe and utilize inexpensive foreign labor, inexpensive shipping costs, and lean inventory systems to produce next-day or even same day delivery.
Modern supply chains are dynamic, complex systems with a single-minded focus on efficiency. The unintended consequence of that system is that it’s fragile by design, with disruptions quickly cascading into catastrophic failure. The pandemic has shown that any system that scales too far will inevitably collapse under its own weight. We are in the middle of an inventory adjustment that spans the globe, a process that supply chain experts have dubbed the bullwhip effect, where fluctuations in demand lead to ever larger disruptions along the supply chain.
MODERN SUPPLY CHAINS
Customer demand is rarely stable and must be estimated to position inventory and other resources. Businesses carry safety stock to buffer these changes, usually in warehouses near retailers, but advances in supply chain technology have reduced these safety stocks to minimize costs. With demand forecasts improving, the supply chain itself acts as the warehouse, with cargo containers on ships, trucks, and
rails serving as a warehouse-in-motion. Goods from around the globe arrive via truck on one side of the distribution center for immediate repackaging, regathering, and retail distributing hours or days after delivery instead of months (as would be the case in a traditional warehouse). Goods are packaged to retailers with automated ordering systems to keep on-hand inventory to a minimum since anything that sits on a shelf costs money to store.
These supply chain innovations have drastically reduced the inventory-to-sales ratio, which is the months of supply retailers have on hand to buffer changes in demand. This ratio has been on a steady decline over the past 30 years, and prior to the pandemic, meant that your average retailer would completely run out of goods to sell in a little over six weeks. This was never a problem since the just-in-time restocking of goods happened every week or, in some cases, daily.
I’ve seen gluts not followed by shortages, but I’ve never seen a shortage not followed by a glut. -Nassim Taleb
2023 will see a slowdown in global trade, quite literally in terms of global shipping, as international shippers adopt slow steaming efforts to reduce carbon emissions, reduce fuel costs, and raise freight rates, causing retailers to liquidate and take losses on excess inventories. Rest assured, as these economic distortions are removed from the system, pandemic excesses, and supply shocks will eventually revert.
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Thomas Galvin is the Director of Research for Stream Realty Partners’ Southwestern Region. He is a real estate economist with a focus on understanding and explaining macroeconomic trends through a commercial real estate lens.