Paul Gooch

FIRST A PANDEMIC, NOW A WAR

BY PAUL GOOCH

WHO REMEMBERS THE 2008 FINANCIAL CRISIS AND ITS IMPACT ON SUPPLY CHAINS? ARE WE FACING LEHMAN BROTHERS 2.0?

Those who fail to learn from history are condemned to repeat it (George Santayana, 1905).

Since early 2020, chemical companies have been challenged to adapt their supply chains to meet the various disruptive forces associated directly or indirectly with the pandemic. Operations have been severely impacted by capacity limitations, sky-rocketing freight rates, lockdowns, shuttered plants, shortage of workers, inventory bull-whip effects etc. All of this has been well documented - we don’t need to spill more ink on the subject.

The pandemic has been called a Black Swan event, although the prospect of a pandemic had been predicted and some chemical companies had a prepared response developed by their crisis management teams.

The same can be said for the invasion of Ukraine. Speculation about such an event has been circulating since 2014, but the general reaction has been denial; Putin wouldn’t do it, would he? Well, he did. Again, hardly a Black Swan.

Apart from the humanitarian tragedy, what we are seeing now is an implosion of the Ukraine economy. If businesses haven’t been razed to the ground, they are shuttered because all the manpower has been mobilized. For example, some automotive plants in the West (such as the BMW Mini plant in the UK) have restricted production because of a shortage of parts from Ukrainian suppliers. Exports of commodities through Black Sea ports are blocked. Supply chains in Ukraine are broken, and likely to stay that way for the foreseeable future.

So where’s the connection with Lehman Brothers? As a result of global sanctions, we are witnessing the withdrawal of many Western corporations from Russia: Renault, VW, IKEA, BP, Shell, ExxonMobil, Boeing and Airbus, just to mention a few household names. As they will be leaving their assets on the ground in Russia it means that they may have to take significant write-offs, and potentially default on loans, which will impact the balance sheets of creditor banks. It is reported that BP alone may be faced with a $25bn write-off from its Rosneft withdrawal.

The next stage may be for suppliers in the West, who have built capacity to supply Russian customers based on bank credit, to default on their loans. The banks will be forced to make provisions for these write-offs.

Credit lines may dry up and the markets could face another Lehman Brothers scenario. However, in this case, unlike in 2008, central banks are barely able to step in by reducing interest rates (already low) or printing money in a high inflation environment. On the other hand, as a result of the financial crash, banks today have a higher equity ratio than in 2008.

During the Financial Crisis in 2008 there was a contraction in demand across numerous industries, which challenged global supply chains in an unprecedented fashion. This was followed by the collapse of Lehman Brothers in September 2008, which triggered a severe recession and so-called demand destruction, leaving many companies struggling to survive. The chemical industry was severely impacted with demand dropping as much as 40 per cent year-on-year. Orders simply dried up.

Today, with global supply chains still recovering from the disruption caused by the pandemic, world trade is being hammered again by the impact of sanctions. Major container lines are no longer accepting bookings for shipment to or from Russia, air freight is faced with major rerouting around Russian and Ukrainian air-space, oil is at $140/bbl, inflation is at a 40-year high, and it’s probably just a matter of time before the Trans-Siberian railroad becomes closed to container traffic between China and Western Europe. FourKites (a supply chain solutions provider) has predicted that container rates from Asia to Europe could double or even triple from their existing, already elevated levels.

On 18 January (before the impact of the war in Ukraine), Yossi Sheffi, director of MIT’s Center for Transportation & Logistics, wrote that “the storm clouds of a global economic recession are gathering on the horizon…and companies are well advised to start thinking about how to prepare for the downturn that could compare to the 2008 financial crisis”.

What can we learn from the 2008 Financial Crisis experience that can be applied to 2022 as the industry faces a possible Lehman Brothers 2.0, and a global recession?

Companies that survived the Financial Crisis demonstrated rapid and decisive steps in protecting their internal and external supply chains. “Necessity is the mother of invention” and this proved to be the case. For example, BASF developed flexible solutions in its ‘Verbund’ business model that would previously have been considered impossible. The need for innovative solutions is as important today as it was in 2008/9.

In October 2014, Supply Chain 24/7 published a report on ‘Five lessons for Supply Chains from the Financial Crisis’. The lessons are still relevant today: 1. It is critical to understand true demand, challenging forecasts in order to obtain reliable information, maintaining close contact with customers (and eventually customers’ customers), and building demand scenarios with associated supply chain contingency plans. 2. The pandemic has revealed the fragility of global supply chains, especially in the case of over-exposure to lower tier suppliers, and extended lead times. Companies need to undertake a detailed mapping of their eco-system to understand potential supply as well as compliance risks. The risk of critical supplier bankruptcy will be high as the recession bites, so alternative sourcing options need to be kept open. 3. It is inevitable that variability of supply and demand will require agile and responsive supply chain models and networks. Smart contracts and a move away from fixed to variable costs is always prudent, especially in tough times. 4. Despite the pandemic causing supply managers to reconsider Just-in-Time (JIT) business models, the need to prudently manage working capital will still be a business priority. There may be a need to prune the product mix in order to eliminate slow moving inventory, and adjust service offerings. 5. The final lesson was to prepare for the upswing, which in 2009 caught many supply chain managers by surprise. The recommended preparation included retaining talent, having a bench of long-term projects ready to go, and providing upside capacity. In the current conditions, a rapid recovery in global trade and return to historical trade lanes seems unlikely, especially if high interest rates, sustained high oil and other commodity prices, and continuing sanctions cause a collapse of consumer demand.

The risk as always is that there will be a typical over-reaction, with ‘across the board’ cost cutting, zero-based budgets, personnel cuts, and severe pressure on suppliers, just to name a few examples.

But what’s different this time around? One observation is that the pandemic has accelerated the digitalisation of supply chains, for example in the area of real-time supply chain visibility and predictability solutions. Companies such as Project 44, FourKites and Shippeo have been successful in raising funding and building out their offering to a growing customer base. This could prove critical for shippers in maintaining a degree of control over disrupted and constantly changing supply chains and service levels. However, this does assume that these digital solutions are not stand-alone, but strategically integrated with other business processes.

Paul Gooch The Logical Group GmbH 7 March 2022