Marc Levinson

Tag: Risk

  • Fixing Chains

    “Shipping costs have finally slumped,” the Financial Times asserts. Bloomberg affirms that trend, contending that container shipping rates are past their peak. With retailers like Walmart and Target now taking charge of their supply chains by chartering ships to move some of their goods across the Pacific (albeit at extremely high cost), the supply-chain crisis may be starting to fade from the headlines.

    That’s not entirely a good thing, because many manufacturers and retailers still haven’t drawn the correct lessons from the past year’s confusion.

    Three factors caused international supply chains to seize up in the summer of 2020. First, starting early last year, governments and central banks everywhere stoked their economies to avert a pandemic-related depression, giving consumers massive amounts of money to spend. Second, COVID-19 forced a major shift in spending patterns in much of the world; with restaurants closed, vacation destinations off limits, and easy money burning holes in their pockets, consumers binged on the sorts of goods that move in shipping containers. Third, as I’ve written in Outside the Box, companies persistently misjudged the risks of long, complex value chains, focusing almost entirely on the production-cost savings of making shoes or dining tables in Asia without adjusting for the risk that the goods might not arrive as promised.

    The first two of those forces are how history: the economic stimulus that drove the consumer spending boom is gradually being withdrawn. The third, however, is still very much with us. There is surprisingly little evidence that major companies are moving to create redundant sources of parts and raw materials, to assemble their finished goods in multiple places, and to find multiple paths to move their goods to market. Even the threat that recurrent tensions between China and its trading partners will disrupt the flow of trade doesn’t seem to be making much of an impression on executives concerned about maximizing this quarter’s profits.

    The onus now is on investors. Careful questions are in order. How are firms building redundancy into their supply chains? How are boards overseeing supply-chain risks? Inattention to the risks of globalized manufacturing holds dangers for shareholders, and falling freight rates and diminished port congestion won’t make those risks go away.

  • My Supply Chain Problems

    I got a ring today from Haverty’s, the furniture store. Last winter — January 16, to be precise — my wife and I purchased a sofa there, with delivery promised for May. In March, I got a phone call: there were delays, and the sofa would arrive at the Haverty’s warehouse, in Atlanta, on July 13. That schedule has now been abandoned. Today’s news was that our sofa is expected in October. By then, Haverty’s will have had the use of our money for nine months and delivered us nothing in return.

    The sofa, by the way, is to be made in Mississippi. The problem, it seems, is that the blue fabric that is to cover the frame and the cushions comes from China. It apparently hasn’t been delivered. The salesperson explained that the entire furniture industry is having supply-chain problems. My response to her was that I don’t accept this excuse. As far as I’m concerned, the problem lies not with China or with the ship lines that are to carry the fabric, but with Haverty’s. The company has badly mismanaged its supply-chain risk, and my wife and I, as its customers, are bearing the cost.

    Let’s be clear: supply-chain interruptions aren’t always avoidable. Things happen. Earthquakes and fires disrupt factory production. Ships and trains run behind schedule. Deadlines are missed. No business operates a hundred percent according to plan.

    But well managed businesses seek ways to control those risks. They purchase inputs from different places (no one told Haverty’s to order all its upholstery fabric from China). They ship those inputs via different routings (overdue ships may be bobbing in a long queue outside Long Beach harbor, but there aren’t long delays in Houston or Savannah). They use multiple plants to turn those inputs into finished goods. They build resiliency into their supply chains, which usually means building redundancy into their supply chains.

    If Haverty’s had done that, it might have had some options to offer us when it first informed us in March that our sofa would not arrive on schedule. Perhaps we could have switched to a different upholstery fabric, not made in China, that would have been available sooner. Perhaps we could have changed our order and selected a different sofa, assembled in a different location, that wouldn’t have taken so many months to produce. Instead, its failure to manage supply-chain risk left us, its customers, exposed to its inability to make good on its promises.

    Alas, our sofa is only a small part of a much larger story. Many, many retailers and manufacturers have misjudged the risks of long and complicated supply chains. In seeking to minimize costs, they have failed to incorporate the risk of business interruption into their cost calculations. The cost is very real: finding customers is a significant expense for most businesses, and driving them away by failing to live up to promises is money down the drain. Once potential business interruptions are accounted for, many of today’s supply chains may not make sense.

  • General Average

    In the modern world of global commerce, it isn’t easy being small. Yes, if you go on the internet to book passage for a container of your precious cargo, the ship line will accommodate you. But you may be sorry. You’ll have to pay the carrier’s published rate for your box, which will undoubtedly be far higher than the rates negotiated by the large manufacturers, retailers, and freight forwarders that ship hundreds of containers each week. You’ll be subject to all sorts of indignities from customs authorities and security officials who are suspicious of unfamiliar shippers, likely delaying your goods. And, in case you haven’t heard, you may be on the hook if something goes wrong with the ship that is carrying your cargo.

    In the eight days since Evergreen Marine’s ship Ever Given was freed from the muck of the Suez Canal and sent north to the Great Bitter Lake for inspection, it’s become clear that small shippers are likely to be among the biggest losers from its ignominious grounding. The reason is something called the General Average, a practice that requires a shipowner and the shippers whose cargo is aboard to share the costs of saving the vessel after a major casualty.

    In this case, the shipowner, the Japanese company Shoei Kisen, has declared a General Average and has engaged a London-based insurance adjuster called Richards Hogg Lindley to figure out the value of each of the thousands of shipments on board. Once the cost of the casualty has been determined, each owner will be assessed a proportionate share of the costs, usually expressed as a percentage of the value of its cargo.

    Figuring out the cost of the casualty will take a while. In order to get the ship underway sooner, the cargo owners are expected to put up deposits to have their cargo released. For most big companies with goods aboard, that should be no problem: they’ll call their marine insurers, who will provide guarantees. But small shippers — think of a tiny umbrella manufacturer in south China, or a Belgian discount store with an order of cheap blouses on the way — may have skipped marine insurance to save money. To gain control of their cargo, they’ll need to put up cash deposits, but they may be hard pressed to raise the cash without controlling the cargo. If they fail to resolve this chicken-and-egg problem, the ship owner can hold and, eventually, sell the goods. Some of the shippers may lack the resources to withstand the loss.

    As maritime accidents go, the grounding of Ever Given will probably not be among the most costly. Even so, there are likely to be many parties that claim damages, including Egypt’s Suez Canal Authority and the owners of the hundreds of vessels that were delayed while the canal was closed. We can expect to see enough claims and counterclaims to keep lawyers busy for years. And I expect we’ll read the sad stories of small business owners with big dreams, who discovered that the global marketplace hides risks they’d never thought about, such as responsibility for an accident they did not cause.

  • The Risks of China

    “We have no choice but to follow the party,” a Chinese seafood entrepreneur told the Wall Street Journal recently. The Chinese government, the Journal asserts, is increasingly forcing private firms to follow Communist Party guidance and using its control over financial markets to punish those that don’t comply. In the process, state-owned enterprises are playing a larger role in the economy, reversing years of effort to downsize the state sector and expand the economic role of private investment. It’s a pretty good bet that China’s economy will become less innovative in the process.

    This development is one more nail in the coffin of what I have called the Third Globalization, the period when international trade grew by leaps and bounds due to long, complicated value chains. As I point out in Outside the Box, this model gained favor in the late twentieth century in part because the corporate bean counters who demanded that manufacturing be located where production and transportation costs were lowest failed to account for risk. Yet risks can’t simply be wished away. If goods don’t get delivered on time, investments are confiscated, or proprietary information ends up in the hands of potential competitors, the costs of long value chains can far exceed the advantages of low production costs and cheap shipping.

    As foreign businesses see it, China now has risks in spades. Dozens of foreign companies, from Abercrombie & Fitch to Zara, face the threat of of trade sanctions and customer displeasure due to allegations that their value chains include producers who use forced labor in the western province of Xinjiang. Foreign banks lost an estimated $400 of fees in an instant when the Chinese government blocked a $40 billion stock offering by the financial company Ant Group in November. The threat that Communist Party functionaries will play a greater role in guiding the activities of foreign-owned enterprises and joint ventures in China is just one more risk that has to be pencilled in.

    In response to the perception of greater risk, firms are carefully shifting their supply chains out of China and are trying to avoid tying up their money there. According to OECD data, the stock of foreign direct investment in China, which was around 25% of the country’s GDP between 2008 and 2016, fell five percentage points between 2016 and 2019. (For comparison, the share in the United States is over 40% and rising.) In 2019, the net inflow of foreign direct investment into China came to 1% of the economy, the lowest level since 1991.

    Skip the eulogies: globalization is by no means dead. But as firms and governments assess its true costs, the global economy is looming less important in our lives. We can expect international trade in goods to grow more slowly than the world economy over the next few years, and perhaps to start declining. One consequence, as Paul Krugman wrote recently, is that “America’s future will be defined by what we do at home, not on some global playing field.” The came could be said of many other countries as well.

  • No, the Coronavirus Won’t Kill Off Globalization

    The spread of COVID-19 has brought much commentary about the impending end of globalization. While the virus has indisputably disrupted the world economy, I think that many of the claims about its impact on international trade are overblown. Globalization is far from dead. Rather, it is changing in ways that were already apparent well before COVID-19 appeared in Wuhan last December.

    When people talk about globalization, they often have something specific in mind — the long value chains that have reshaped the manufacturing sector since the late 1980s. These chains emerged after the development of container shipping, falling communications costs, and more powerful computers made it practical to divide a complex production process among widely dispersed locations, performing each task wherever it is most cost-effective to do so.

    Value chains underlay the torrid growth of international trade in the final years of the twentieth century and the early years of the twenty-first. During those years, trade grew two or even three times as fast as the world economy, mainly because of increased shipments of what economists call “intermediate goods,” items made in one place that are being sent elsewhere for further processing. I refer to this period as the Third Globalization, because it was distinctly different from other periods — the decades before World War One, the years between 1948 and the mid-1980s — when international trade and investment grew rapidly, but international value chains were uncommon.

    Many companies decided where to locate various parts of their value chains based on production and transportation costs. But over time, complicated long-distance value chains often proved to be less profitable than they had imagined. As freight transportation became slower and less reliable, and as earthquakes and labor disputes resulted in goods not arriving on time, executives and their shareholders became more attuned to the vulnerabilities. Minimizing production costs ceased to be the sole priority. 

    Companies have taken a variety of measures to reduce risks in their value chains. They are keeping larger inventories in their warehouses, producing critical components at multiple locations rather than in a single large plant, and dividing exports among several ship lines and sending them through different ports. All of these measures help limit losses when value chains malfunction. But all of them make international sourcing more expensive.

    For most of the past decade, international trade has grown more slowly than the world economy, reversing the trend of the previous sixty years. Greater care when it comes to arranging value chains is one reason why. COVID-19 offers further reason to be careful. But it is not likely to cause manufacturers, wholesalers, and retailers to give up on globalization. The alternative, relying on a purely domestic value chain that can be interrupted by a flood or a fire, might create risks rather than contain them.