It has been almost two years since the first signs of inflation ignited by the COVID-19 pandemic began appearing across the global industrial landscape. From the summer of 2020 to late 2021, prices were rising virtually across the board, from raw materials to labor. We wrote about the situation back then, and offered advice for global private capital investors and operators on how to extract strategic sourcing value in an era of hyperinflation. Since then, conditions have begun to change. The signals are a bit more mixed today — presenting different imperatives for different businesses as well as for private equity investors whose portfolios are global in their supplier footprints.
In many regions, pandemic-driven restrictions have begun to ease as businesses and governments shift toward a new normal during COVID-19. (The one major exception, of course, is China, which has returned to the full lockdown response of early 2020.) As most other nations get back to business and pandemic fiscal measures phase out, the massive labor shortages that plagued companies in 2020 and 2021 have started to subside. In the United States, for example, the phaseouts of fiscal stimulus, foreclosure moratoria, and extended unemployment insurance, combined with rising wages, have coaxed more people back to work. Unemployment in March was just a tenth of a percentage point above its level in February 2020. Meanwhile, the labor force participation rate, which measures the percentage of the population either working or actively looking for work, was 62.4% in March, up from a multidecade low of 60.2% in April 2020. While that isn’t quite back to the pre-pandemic level of 63.4% recorded in February 2020, the trend is clear.
While the labor-shortage picture is improving, conditions remain challenging for several raw materials. Prices for many remain in hyperinflation — in some cases driven even higher by the outbreak of war in Ukraine. The cost of plastic, for example, spiked as Russian tanks moved across the border to Ukraine; in the United States prices are now 71% above their pre-pandemic level, while in Europe they have surged 112%. Steel prices have also jumped, and now sit 76% higher than their March 2020 level in the United States and 184% higher in Europe. It is a similar story for aluminum: spikes on the London Metal Exchange since the war in Ukraine have left prices 98% higher than they were in March 2020. Perhaps no single commodity tells the story of hyperinflation and supply chain woes better than overseas shipping container rates, which now sit an astounding 822% higher than they were on the eve of the pandemic, as measured by the Freightos Baltic Index of China/East Asia to Northern Europe. Simply put, while labor shortages are easing, raw materials prices aren’t normalizing.
The implications for business are enormous. The mixed-bag situation of today presents an opportunity for companies to seize opportunities that come with a return to normalcy. A year ago, conditions were highly fragile; now there is less COVID-fueled pandemonium and companies should be more willing to view the current environment with an opportunistic lens, as opposed to waiting and watching. The biggest improvements will come on the value-add side of manufacturing, where companies can tap their growing workforces to optimize cost structures.
In today’s seemingly chaotic but value-rich sourcing environment, the biggest key to success will be in drawing the distinction between purchased items with meaningful value-add steps and components that are 80% or more raw material-dependent. Examples of components with meaningful value-add steps include plastic and aluminum extrusions, stamped or machined metal parts, molded plastic products, motors, fans and other semi-finished goods, and so on. Raw material-dependent components include steel wire rod, plastic resin, metal ingots, and other items.
In the current environment, cost structures of components with higher value-add steps have been somewhat insulated from wild raw material price fluctuations, given that raw materials generally comprise no more than 15% of the total cost of the component. In contrast, heavy raw material-dependent components have been susceptible not only to continued rising prices but also to extreme swings, which have made planning difficult.
In addition, many previously “underrepresented” markets have gained meaningful share from the more established raw material markets. For example, several types of lumber and wood products like furniture, previously thought of as a China/East Asian stronghold, are now being sourced from Eastern Europe at a growing rate. The massive hike in ocean shipping rates from Asia has made European suppliers significantly more cost competitive. Of course, the war in Ukraine might change the dynamics there as well.
The COVID-19 outlook in China remains the biggest variable on the supply chain front, while the war in Ukraine holds the potential to cause continued price increases of many raw materials, particularly in Europe. However, considerable progress is being made in labor supplies, which are projected to return to normal slowly but surely in many regions of the globe. Private capital investors and operators need to act now to seize value-creation opportunities centered on optimizing the costs of procured materials while simultaneously identifying potential acquisition targets with true latent value. Although the global economy remains very much in flux, companies with unwavering focus can identify and capture the opportunities bred by the current supply chain scramble.