When it comes to the supply chain, few things have captured people’s imaginations more than last year’s shipping queues off of the California coast. While those lines are long gone, the supply chain is not only worse off today, but quickly approaching a near and total logjam.
Production in China
Let’s examine today’s supply chain woes by following the path a widget must take from the factory floor in China to our front door.
In today’s environment, that widget would have to contend with political, economic, and environmental risks. The Chinese government is engaging in ongoing lockdowns to contain COVID that shut down manufacturing hubs or their suppliers at any given moment. The continued deterioration of the Chinese economy risks bankrupting critical suppliers or having wild swings in commodity prices that endangers affordability. Historic typhoons close the ports for days, while the worst heat wave China has ever experienced forces factories to shut down due to lack of power or water. All the while, tensions in the South China Sea disrupt trade routes and risk destabilizing the region.
Once that widget has been made, it is then placed on a pallet. Pallets are also in short supply due to high demand and the Russian invasion disrupting the lumber trade. Once on the pallet, it is loaded on the back of a shipping container and then off to the ports.
For that widget to make it to the US, it will most likely travel by ship. Boats are the single cheapest way to transport cargo. 90% of the world’s goods travel by ship, 80% of that is bulk cargo, and 20% is inside shipping containers. For international travel, most of the remainder travel by plane, utilizing excess capacity in passenger jets or specialized cargo planes. Very large cargo, like equipment for the oil and gas industry, is delivered by Antonov planes. Antonov is a Ukrainian company that had its operations disrupted during the invasion. Their flagship plane, and the world’s largest jet, the AN-225, was destroyed in the first days of the Russian invasion.
Over the past several decades, we have seen significant consolidation in the shipping industry. Today, the industry is controlled by three major shipping alliances that function as integrated companies, sharing ships and containers.
- 2M: Maersk and MSC
- Ocean Alliance: CMA, CGW, COSCO Group, OOCL, Evergreen
- THE Alliance: Hapag LLoyd, Yang Ming, MOL, K-line
That consolidation has led to unreasonable fees and price hikes that ultimately get passed along to the consumer. In response, the Ocean Shipping Reform Act was passed in June 2022. This act empowered the Federal Maritime Commission to regulate shipping fees and ensure that shippers couldn’t decline exporting American cargo.
For shippers, the biggest expense of transporting cargo is fuel. Since the late 2000s, ships have engaged in a practice known as “slow steaming” which can lower fuel costs by 59%. However, they go much slower than their max speed and this practice adds a week to the journey. With volatility in the energy markets, many shipping companies are exploring adding “wind-assisted propulsion”, aka sails, to increase fuel efficiency by an additional 20%.
In contrast, in January of 2020, new shipping regulations went into effect to substantially reduce sulfur emissions from ocean carriers. The regulation is expected to cost the industry $60B in retrofitting scrubbers and additional higher-quality fuel costs. The cost of shipping is also increasing with the scrapping of older ships. These are often replaced with the more fuel-efficient Neo-Panamax vessels, which is the largest possible vessel that can still make it through the Panama Canal. However, with the newer super-sized ships, new problems are presented: making it in and out of ports and canals.
Now that our widget has made it to the US shores it will need to enter a port. This isn’t as simple as one would think because US port infrastructure hasn’t kept pace with modern ships.
To enter a port, a ship must travel through a given channel and not get stuck. The Neo-Panamax Ever Given captured the world’s attention as it ran aground in the Suez Canal, blocking 12% of world trade for a week. A year after that, another ship, the Ever Forward, ran aground in the Chesapeake Bay and was stuck for five weeks. Reducing Baltimore’s port to one-way traffic and costing the carrier $100M.
The dredges used to free the Ever Given could move 70,000 cubic yards an hour, while the US dredges that freed the Ever Forward could only carry 60 cubic yards an hour. That is not a typo. The large discrepancy comes from The Foreign Dredge Act of 1906, which requires all US dredgers to be owned, built, and crewed by US companies.
The anti-competitive legislation has resulted in the largest American dredgers only capable of moving a maximum of 10K cubic yards. US dredging projects cost 2-4x as much and take 2-3x as long as foreign dredgers.
The Port of Houston, which used to be a 2-lane channel, has been reduced to one-lane stop-and-go traffic that can’t even accommodate Neo-Panamax vessels due to a lack of dredging. Dredging the port of Houston would decrease export costs by more than 15%, but the cost to do it is prohibitive.
A lack of port capacity helped contribute to last year’s 109 ship queue outside the ports of Los Angeles and Long Beach, yet few realize that the queues today are at an all-time high. Afraid of repeating last year’s lines at the west coast ports, particularly during ongoing union negotiations, a significant amount of cargo got redirected this year to the ports of Houston, Savanna, and New York. As of August 2022, 153 ships are queued outside American ports, beating last year’s peak of 150. As peak shipping season passes that is likely to decline.
Once our widget-bearing container ship has reached its berth, it will begin unloading. In conventional ports the shipping containers are removed from boats via the ship-to-shore crane and placed on the back of a yard tractor. This moves the container inside the port to be picked up by a stacking crane and put into storage. In automated ports, containers are placed directly on the ground where a crane called an autostrad lifts the container to where it will be stored. Next, an automated stacking crane lifts and places the container into storage.
Automation is the best way to improve port efficiency, yet only about 3% of all global shipping terminals are automated. The ports of Los Angeles and Long Beach are about 33% automated. When taken together, it is the largest port in the US and accounts for 50% of all goods arriving from Asia.
In November 2021, with the passage of the Bipartisan Infrastructure Law, $17B was allocated to the modernization of US ports and waterway infrastructure. But those improvements will take years to manifest.
Most goods will leave the terminal after a gantry crane places the container on the back of a truck with a chassis. That truck driver, known as a drayage, will make loops between the port and warehouses within about 100 miles. Those warehouses will cross-dock goods by mixing and matching pallets from the containers into a dry van or refrigerated units known as reefers. These goods will never be entered into inventory. From there, an Over-The-Road (OTR), aka long haul trucker, will take the load to a warehouse or fulfillment center.
Drayage truckers are paid either per mile or round trip and are not compensated for loading or unloading containers. Turnaround times for drayage truckers at fully automated terminals are as little as 45 minutes, whereas a conventional port averages 90 minutes. During the height of the port clog, turnaround times grew to as much as 4 hours. This caused many drivers to leave and find work elsewhere, further hampering the system.
Those drivers may have found work in OTR trucking which has had its own long-lasting problems. In 1980, Congress passed the Motor Carrier Act which was intended to fight inflation through deregulation. Within two years, it helped cut truck transportation costs by 25% through new market entrants buying top-of-the-line fuel-efficient vehicles as well as an explosion of competition that drove down pricing. Before the MCA, a truck driver earned $120K on average which was largely due to the Teamsters union. By 2019, the average driver made $45K, a 63% decline. Highly coveted senior positions driving for retailers like Walmart make, on average, $68K a year.
There are 3.5M truck drivers in the US and about 50% of them are OTR. While trucking companies may complain of a driver shortage, there are 10M Americans with commercial driver licenses. When a genuine shortage does occur, as it did last year, spot rates shoot up and drivers re-enter the market. When the industry enters a recession, as it is right now, small providers exit until an equilibrium emerges.
Many companies are trying to fix issues in the trucking industry through automation. For example, Uber Freight is trying to automate the freight brokerage industry through appification. However, cargo is much more complex than taxis. There are 40 different characteristics that go into each load and while canceling a taxi might be an inconvenience, canceling a cargo load anywhere in the process could costs tens of thousands of dollars.
The holy grail of the trucking industry would be self-driving vehicles that could roam 24 hours a day and wouldn’t be limited by the 11 hour cap that human drivers have. However, a vehicle that can self-drive in all conditions including snow, heavy rain, construction zones, and city streets, is still a long way off.
In addition to trucking, there is another way for cargo to leave the port, particularly for customers who order entire shipping containers. 40% of long-haul loads leave the port on a train, referred to as intermodal, to be sent as close to their final destination as possible before being loaded onto a truck chassis.
The railroad industry used to be filled with high-paying union jobs and 8 hour work days until the 2010s when railroad companies began implementing Precision Scheduled Railroading (PSR). Instead of trains waiting for cargo to arrive, customers now had a set time to pick up a customer’s cargo and the results have been disastrous.
Dwell times in the station increased by as much as 26 hours. A trip that used to take a few days would now take up to 2 weeks, with only 67% of trains now arriving on time. From the railroad operator’s perspective, it allowed for the creation of super long 3-mile trains and asset efficiency. While it allowed companies to slash labor by 29%, employees now would work 12-19 hour shifts and have to walk multiple hours to find and fix a problem. Railroad operators are trying to hire and recover from pandemic-related furloughs but are struggling to find workers who want to operate under such conditions. Additionally, their current labor force is in ongoing negotiations to prevent a strike that would be catastrophic for American commerce.
Regardless of that outcome, there is currently a backlog in intermodal. In LA, containers are waiting 3-4 times the normal average for rail cars due to backups further inland and insufficient labor in the railroad industry.
Once our widget has reached the warehouse, goods are depalletized and are entered into inventory where they will wait to be ordered by a customer. Once ordered, the item is picked, placed on a conveyor, packed into a cardboard box, and then sorted to determine which delivery truck will take the package to its final destination. If a warehouse doesn’t have a sorting machine, or the parcel will be delivered somewhere greater than 100miles from the warehouse, then another truck takes boxes from the warehouse to a sorting facility to be processed.
In response to supply chain issues, retailers decided to over-order inventory to ensure continued supply to consumers. However, with inflation rising in durable goods as well as consumer spending shifting to travel and services over the summer, many major retailers are now stuck with excess inventory. That inventory doesn’t just fill shelf space, it also creates a logjam that backflows through the supply chain. With store shelves filling up, local warehouses get filled up, which has now led to the largest warehouse and distribution area, the Inland Empire, to run out of room. Not only that, but rail lines also get backed up, which creates a glut at the ports.
Similar to slamming on the break and gas simultaneously, this excess inventory has barely made a dent in additional imports as companies loaded up on the ‘wrong’ goods. Retailers are now being forced to heavily discount items to clear the logjam. If consumer spending shifts back towards goods, for example, during the holiday season, or if longer-term inflationary expectations take hold, we could see this period of too much be followed, yet again, by too little.
Warehouses aren’t intended to hold items for long periods but instead are optimized for the flow of goods through the system. As of 2019, 15% of Amazon’s warehouses included robots while about 5% of all US warehouses use automation. As demographic decline boosters long-term labor shortages, automation investment in warehouses will likely take off.
The industrial robots of yesteryear are large, highly durable machines designed for the automotive industry. The newer robots are designed for simpler tasks, are much cheaper to produce as well as maintain, and will eliminate dull, dirty, and difficult jobs.
Currently, robotics-as-a-service firms like Polar are leasing small-scale automation robots for as little as $8/hour. Longer term, companies like Plus One Robotics in San Antonio are attempting to create machines that can match the dexterity of the human hand, allowing companies to automate the pickers and packers in warehouse operations as well.
The last stop on our widgets journey is being placed on the back of a delivery truck and brought to our homes. Much of this work is outsourced to contract labor which is in short supply due to low wages as well as rank and yank management.
Former GE CEO, Jack Welch, first popularized stack ranking, where all employers are periodically ranked, with the bottom 10-25% being let go. The system invites abuse, from sabotaging others to save oneself to perpetually hiring fall candidates that are intended fodder to always keep the employees a manager wants. While most white-collar professions abandoned the practice long ago because of its harmful effects on morale and productivity, Blue collar work has kept the practice because of minimal onboarding times and its anti-union effect. Amazon’s rank and yank system works because they set the industry’s wage floor, ensuring they always have a new supply of labor.
An ample supply of new people entering the field is the critical underlying assumption and it’s beginning to break down. Blue collar industries that rely on this churn and burn model have high turnover rates: retail at 60%, trucking at 100%, and fast food exceeding 100%.
While business owners fret about competing against Amazon for labor and fighting unionization internally, few seem to have plans for the next few years when factories start opening up down the street and offer north of $40/hr. For every Fortune 500 company that announces a new facility, another 5-10 supplies co-locate additional production and warehousing, perhaps, doubling the top-line labor demand.
The return of high-paying factory jobs in the US will be the last nail in the supply chain coffin. To compete, blue-collar employers will have to abandon churn and burn systems. This will empower unionization efforts and raise wages that will drive up logistics costs, incentivizing more companies to reshore operations.
To Be Continued In Part 2