The Supply Chain Challenge
Construction Industry Bolsters Inventories, Woos Suppliers to Keep Customers Happy
Phillip M. Perry / October 2021
Abstract: The increasing demands of a rebounding economy are stressing supply chains already disrupted by the COVID-19 pandemic. Dealing effectively with the resulting delivery delays requires better coordination with suppliers, locating of back up sources, bolstering of inventories, and boosting automation. Businesses must evaluate the risks attendant with an uncertain recovery path while dealing effectively with increases in the costs of raw materials, labor and inventory.
A rebounding American economy is putting new pressure on the nation’s supply chains. Faced with robust consumer and commercial demand, companies are beefing up costly inventories and wooing second-level suppliers to close the delivery gaps.
“Material shortages caused by supply chain disruptions continue to linger in the construction industry,” says Anirban Basu, chairman and CEO of Sage Policy Group (sagepolicy.com). “The failure of suppliers to keep up with demand impacts the prices of many construction inputs such as softwood lumber, steel, gypsum and natural gas. In fact, contractors are paying about 23% more for such inputs than they were a year ago.”
Prices generally remain well above pre-pandemic levels even with the recent declines in softwood lumber and copper, notes Basu. “This is the case despite the fact that by many measures the economy has not fully recovered. The nation is down about six million jobs since the onset of the pandemic, and unemployment is nearly two percentage points higher.”
Product shortages and delays—and their associated price hikes—have long been familiar issues at enterprises large and small. “For a number of years our member companies have been dealing with disruptions caused by factors such as tariffs and higher energy costs,” says Tom Palisin, executive director of The Manufacturers’ Association, a York, Pa.–based regional employers’ group with more than 370 member companies (mascpa.org). With its diverse membership in food processing, defense, fabrication and machinery building, Palisin’s association is something of a proxy for American industry. “The COVID-19 pandemic has given the supply chain a whole new level of priority. Companies in just about all sectors have experienced pauses and shutdowns,” he says. “Some have even gone out of business.”
Prices may well escalate further. The nation seems on the verge of passing a significant infrastructure package that will likely increase the demand for construction inputs at a time when suppliers are operating at capacity. “Whatever the price in the market, suppliers can literally supply no more,” says Basu. “The economy is rebounding forcefully—Delta variant notwithstanding, and construction has rebounded with particular force—especially residential construction.”
As home builders are scrambling to deliver more product in a red-hot market, some firms are hoarding inputs, including lumber, in order to obviate shortages, says Basu. Any inputs sitting in inventory, of course, puts even more upward pressure on prices. And the steep production cuts of early 2020—instituted to obviate excess inventories—has only increased the difficulty of establishing reliable delivery patterns.
Labor shortages are one of the most persistent causes of distribution slowdowns. “One banker told me that his four manufacturing customers could each hire 50 additional workers if enough applicants were to show up,” says Bill Conerly, principal of his own consulting firm (conerlyconsulting.com) in Lake Oswego, Ore. “When a company I work with in Portland was awaiting a shipment of brass from Los Angeles, it turned out there was no driver for the truck.”
The reasons for labor shortages are varied. “Part of the problem is that people are not yet willing to come back to work,” says Conerly. “But the fact is that there were not as many pandemic-related layoffs in manufacturing as in, say, food service. A larger issue is demographics: Older people are retiring, and younger people don’t want to go into dirty, noisy factories. And then you have government cash payments for people who get laid off. And finally, there are childcare issues.”
The labor shortage has caused an increase in automation as a way to produce goods with fewer man-hours. “In recent months there’s been a surge of business orders for capital equipment,” says Conerly. “The fact that manufacturing production has not reached all-time highs, though, indicates that the new equipment is not intended to boost capacity. So I think a lot of the business capital spending is intended to replace empty positions with machines. The idea is ‘If I can’t hire somebody to assemble this product, maybe I can hire a robot to do it.’ And I think that’s a good strategy.”
A decline in the cost of automation has helped fuel this trend. “The cost of labor has gone up while the cost of electronic equipment has gone down,” says Conerly. “Something that did not pencil out a few years ago may well do so today.”
Companies are responding to the supply chain challenge by doing more with less, running machinery beyond its prime and collaborating with vendors to predict shipping delays. Such moves strike a familiar chord with Palisin at the manufacturer’s association.
“The pandemic has really highlighted the need to develop strategies to mitigate potential disruptions in the flow of critical components,” says Palisin. “That means doing a deep dive into the supply chain, mapping the geographical locations of the first tier of suppliers and learning about the reliance of second tier as well.”
Pandemic-related shortages have affirmed the need for backup vendors even for lower volume items. “Instead of relying on one supplier, a company might have three to manage risks,” says Jim Hannan, practice leader of the manufacturing, distribution and logistics service group at consulting firm Withum (withum.com). “We expect this trend to continue with the advent of environmental, social governance standards at larger companies.”
When deliveries are spotty, companies are tempted to keep more stock on hand. “Companies should no longer rely on just-in-time inventory strategies, which too often have become just-too-late failures, and stockpile more supplies both in the United States and abroad,” says John Manzella, a consultant on global business and economic trends, East Amherst, N.Y.
(johnmanzella.com). “This approach reduces efficiencies but favors risk reduction.”
Companies are willing to turn upside down the traditional views of inventory control, given the increased risk of shortages and customer goodwill. “Many companies are investing more cash in inventories, and banks seem content with lending against that,” says Hannan.
While businesses must pay the price for bolstering inventory levels, such costs must be balanced against operational expenses such as the need to pay higher prices for goods when a company scrambles to fill customer orders—or lost revenues when an unhappy customer jumps ship for a competitor. As they balance such costs, many companies are viewing higher cashflow on the shelf as acceptable. “Risk mitigation has become more important than efficiency gains,” says Manzella.
Furthermore, three historic costs of inventories—interest, obsolescence and shrinkage—no longer universally apply. “The interest rate you get for having cash in the bank now is approximately diddly squat,” says Conerly. And obsolescence would only be an issue if something were expected to go out of fashion. “Many products in short supply today are the same products as last year’s model and they are not going to go obsolete.” Shrinkage, he adds, is not an issue in some industries and in others can be controlled with requisite security steps.
Cheap or not, inventory storage must be allocated selectively. “Companies need to be thinking, ‘what might be in short supply when we try to ramp up our production?’” says Conerly. “They may well buy a year’s supply of a relatively cheap item that is a small part of what a company uses but is vital to producing a finished product.”
Despite the need to bolster inventories, a return to the days of bulging warehouses is not in the cards. “Everybody has become accustomed to reducing costs by minimizing touch points, moving goods from the ship straight to the distribution facility and on to the customer,” says one operator. Indeed, cooperative efforts with suppliers and customers may well help bring back a greater emphasis on JIT. “I believe that the economy will eventually get back to that just-in-time concept as market disruptions lapse and the continued collaborative partnerships with vendors and suppliers remain a priority,” says Hannan.
The Road Ahead
Businesses face a conundrum as the world emerges from the pandemic: How quickly will demand increase for products and services, and will the increase be steady or erratic? The wrong answers can result in a pileup of inventory or lost revenues and customers. “The risk is especially great for consumer and business goods requiring long lead times where businesses can’t easily turn the supply chain spigot on and off,” says Hannan.
The solution, says Hannan, is to develop a playbook to address possible disruptions and evaluate risks up and down the supply chain, then develop a plan to address those risks. And management must grapple with other unknowns such as whether the recent surge in the price of manufactured goods can be passed along to the consumer.
All this may soften profits until everything shakes out. “Revenues will probably hold up or even increase because of higher demand, but margins will likely be hit because of increases in the costs of raw materials, labor and inventory,” says Palisin. “It’s a very unusual situation where all of these cost increases are happening at once—and at a time when tariffs are still in place. Companies just can’t pass along everything to customers.”
As for the road ahead, Conerly anticipates a gradual improvement in the operating environment. “Now that people are able to travel, they may well return to spending on vacations instead of home improvements as they did in 2020 when demand for household furnishings and building materials challenged the whole supply chain,” he says. “Consumers who have already completed their projects will be spending their money elsewhere.”
Significant relief to supply chain pressures will come only when suppliers adjust to the demands of the new reality. “One presumes that suppliers will add capacity over the next few years, given the incentive of lofty prices,” says Basu. “There is some effort being made to expand longer term capacity—for instance, by constructing new sawmills or semiconductor manufacturing plants. But that takes time. You don’t put a sawmill plant in place in a matter of a few days or a few weeks. Eventually increased supply will bring down prices, but we might not see meaningful declines until 2022. And maybe not even then.”
In the meantime, many operators feel the declining days of the pandemic provide an opportunity for businesses to gain market share. Says one: “We’re assuming the worst and hoping for the best. Our overriding goal is to protect the health of our people and service our customers. Those things haven’t changed a bit. And we’ll do what it takes to get it done.”
Phillip M. Perry is a full time freelance business writer with over 20 years of experience in the fields of workplace psychology, employment law and marketing. His byline has appeared over 3,000 times in a variety of business publications.