4 takes on what's driving global supply-chain challenges

Whether you’ve been hoping to buy a new car, source fittings to complete a building project, or purchase a new iPhone, you’ve probably experienced frustrating delays in the last 18 months or more. Supply chain disruptions are the likely reason.

Since COVID lockdowns from around March 2020 saw the widespread disruption of manufacturing operations, companies have struggled to get the raw materials and components they need (cup an ear and you can hear the fingers drumming).

The onset of the Omicron variant of the virus in the backend of 2021, Russia’s invasion of Ukraine, and China’s ongoing difficulties getting a handle on the COVID outbreak that started in its key manufacturing hub last December have all contributed to the delays.

In this first of a three-part series on supply chains, I asked the following four fund managers what they regard as the key drivers of the disruptions.

• Vince Pezzullo, deputy head of equities, Perpetual Asset Management Australia  
• Francyne Mu, portfolio manager, Franklin Templeton
• Ben Li, equity analyst and portfolio manager, Fidelity International
• Bill Pridham, portfolio manager, Ellerston Capital.

They were also asked to explain how supply chain issues flowed from the upstream – referring to the material inputs needed to produce goods – to the companies who sell these goods and the consumers who buy them – the downstream.

The march of deglobalisation

Vince Pezzullo, Perpetual Limited

The biggest drivers have been COVID, de-globalisation and other geopolitical factors. The emergence of COVID in early 2020 first disrupted supply chains because many businesses couldn’t get supplies out of key producer countries, like China, as they shut down their factories during the initial phase of the virus. 

Continued lockdowns and other restrictions of this nature still plague supply chains today, with Shanghai and Beijing the latest cities to experience heavy new restrictions as a COVID-zero policy is pursued in China.

Related to the above point, the inability to access key supplies continues in some sectors. In response, many countries and companies are rethinking their reliance on overseas suppliers for their products. 

This shift from globalised manufacturing chains that delivered goods “just in time” via global transport links is being replaced by “just in case” domestic production to guard against future supply disruptions. This trend is driving “de-globalisation” after decades of expansion.

Lastly, geopolitical factors are beginning to emerge. Big power rivalries have been rising for years and have led to restricted flows of technology and other strategic assets. The war in Ukraine has put a sharp focus on energy and food security as the supply of gas and wheat has been heavily disrupted. While price surges have resulted, this is also allowing markets to respond by generating new supply lines, although this will take time.

3 reasons for supply chain challenges

Francyne Mu, Franklin Templeton

The COVID lockdowns highlighted the risks to supply chains, based on the assumption that the move to globalisation and the free flow of goods would remain free from disruption. Companies had been moving towards “just in time” inventory models and outsourcing to lower-cost geographies, which also improved cash flows and provided greater flexibility.

But as the world endured the lockdowns, and with the early issues in sourcing available personal protective equipment (PPE), medicines and semi-conductors, the flexibility provided by this model has been called into question.

Broadly speaking, the problems affecting the supply chain can be classed into three distinct but interrelated issues. These are:

1. Disruption due to COVID-induced labour shortages affecting inbound and outbound logistics
2. Supply shortages within specific sectors related to the ability of companies to acquire parts for finished products
3. Supply chain uncertainty due to war, sanctions, and heightened geopolitical tensions

The early COVID disruption spurred companies to secure and build up their inventory, in the face of ongoing uncertainty. 

But as it became more apparent that later strains of COVID were less virulent, pent-up demand from the re-opening of economies led to a bottleneck in supply inputs and logistical issues.

The current supply chain difficulties are driving increased short-term pressure on companies’ ability to build their inventory. They’re also creating long-term structural changes, including a greater emphasis on the reliability of supplies above the lowest cost solutions, which may continue to affect equity investors.

And the inflationary pressures driven by COVID-induced supply shocks ­– whether in labour or goods – have drawn together economic and political issues. This has resulted in market expectations of a rising interest rate environment.

Beyond de-globalisation

Ben Li, Fidelity International

De-globalisation is commonly cited among the primary causes of the supply chain shocks we’ve seen since around March 2020, when COVID and measures aimed at slowing the spread – including lockdowns – knocked the global economy.

But it’s not simply deglobalisation. We believe “re-globalisation” might be a better term for the shifts we see playing out, as the range and scale of responses are altering supplier networks and behaviour. 

Every market has been affected by these global dislocations. For example, in China, companies have been adapting supply chains to be less reliant on manufacturing on the mainland.

Around 74% of Fidelity International analysts cite the pandemic (74%) and input shortages (70%) as the major causes of supply chain disruptions at the companies they research, according to an in-house survey completed in March.

Other causes include:

• Shipping bottlenecks (55%)
• Geopolitical tensions (32%
• Difficulties in raising capital (8%)
• Tariffs and regulations (8%).

On the geopolitical front, the escalation of hostilities since then has added further difficulties to the already challenging environment globally.

Sustainability and product traceability

Bill Pridham, Ellerston Capital

The COVID-19 pandemic sent shockwaves through global supply chains, as businesses have fought to keep their manufacturing operations running despite shortages of components, raw materials, and labour.

On top of this, sudden spikes in consumer demand have exacerbated the issue and highlighted the rigid nature of current supply chains. Regulatory requirements, investor pressure and consumer expectations have all raised the bar on what is expected of companies.

We can draw insights into the primary causes of supply chain challenges by looking at the key areas that companies are looking to change. All respondents in a 2020 McKinsey & Co survey of 60 senior supply chain executives identified production and distribution problems, and more than 90% had problems with their suppliers. To address these challenges, 93% of respondents said they plan to increase investment and build the resiliency of their supply chains after the pandemic.

The rapidly growing customer demand for organisations and brands that are more sustainable is also driving supply chain changes. For example, in the food and fashion industries, the ability to pinpoint where raw materials come from (their “traceability”) is increasingly important.

Traceability has long been sought after in the food and pharmaceutical industries, where accurate ingredient listing and safety are critical. These capabilities are becoming increasingly attractive to industries outside the typical scope, as companies look to make credible and verified claims against sustainability initiatives. As part of this, corporations are seeing increased scrutiny of their supply chains. Consumers want to know where their products came from and who made them. 

In conclusion

The consensus from the above contributors is that there are three core drivers of bottlenecks:

• the COVID-19 pandemic
• de-globalisation, and
• geopolitics, particularly the Russia-Ukraine war and China.

Some of the others, such as shipping bottlenecks, tariff increases and rising difficulties for companies seeking to raise capital - as mentioned by Fidelity's Yeung - might be thought of as second-order effects related to the above points.

The real outlier among the above responses was from Ellerston Capital's Pridham, who cited sustainability as a key driver of supply chain challenges. This adds a somewhat surprising variable that professional investors may need to factor into their company analyses from here on.

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Enjoyed this wire? Give it a "like" by clicking the button below, you'll also be notified when other parts of this series are published. In parts two and three, our fund managers discuss whether supply chain challenges are structural or transitory, and the attributes of companies that are most resilient to these pressures.