In this episode of Lehigh University’s College of Business ilLUminate podcast, we are speaking with Zach Zacharia about the concerning increase in risk levels facing the global supply chain in the third quarter of 2022, as reported in the latest Lehigh Business Supply Chain Risk Management Index (LRMI).
Zacharia is an associate professor of supply chain management in the Decision and Technology Analytics (DATA) department and director of the Center for Supply Chain Research at Lehigh. LRMI was developed in 2020 by the Center for Supply Chain Research at Lehigh University and the Council of Supply Chain Management Professionals.
Zacharia spoke with Jack Croft, host of the ilLUminate podcast. Listen to the podcast here and subscribe and download Lehigh Business on Apple Podcasts or wherever you get your podcasts.
Below is an edited excerpt from that conversation. Read the complete podcast transcript.
Jack Croft: Since we last talked in December, the global supply chain has been disrupted by a seemingly unrelenting number of adverse and even devastating events, going back to the global COVID-19 pandemic, more recently, Russia's invasion of Ukraine, gas and oil prices soaring to new highs, energy shortages, labor shortages, inflation at the highest level in decades, and increasing examples of extreme weather events caused by climate change, just to name a few. So before we look in detail at the latest LRMI results, I'd be curious to get your thoughts on a more global perspective on the current state of the supply chain.
Zach Zacharia: Actually, any one of those things that you mentioned would have a significant impact on the supply chain, from COVID-19 to high inflation to labor issues and obviously climate change issues. But I think the key factor is Russia's invasion of Ukraine, which has really sort of turned down the whole geopolitical system. So this is a huge issue, and you can see the repercussions all throughout the supply chain.
One of the things that it's important to understand is that businesses in general prefer certainty. In other words, they like to know if the shipment is late as early as possible so that they can plan for it. We tend to plan for the future. Whenever you have greater uncertainty, there is greater risk because now you don't know what is going to happen. You can't be prepared for it. Do you have enough inventory? Do you have enough staff? And all of those things really matter. So when we have the issues that are going on now, you have a lot of uncertainty in the business environment, and you can see some of the consequences.
Now, I don't know if you read this, but Walmart and Target last week announced that they had too much inventory. And in a normal situation, this is extremely surprising because Walmart and Target, over the years, have perfected how much inventory they're going to carry. But this is what Russia's invasion of Ukraine has done. It has completely upended the way that these things work. And so what you have is that you have demand for product, but consumers willing to buy those products has decreased because there is a huge spike in inflation.
And this has led to what is called the classic bullwhip effect. That is where you have initially high demand and not enough inventory. So, therefore, you order a lot of inventory, the demand cools off, and now you have excess inventory. And by definition, we talk about that as a bullwhip effect because small changes in consumer demand have huge or increasing effects as you go further up the supply chain. The bottom line is that, in this economy right now, there's greater uncertainty. And you're going to see companies have to adapt into this uncertain environment, and that's why we have some of the major issues that we're seeing in the index.
Croft: Turning to the latest report in the Lehigh Business Supply Chain Risk Management Index, the overall average risk was 72.36, the second highest since you launched the index two years ago and only slightly behind the first quarter of 2022. So what does that tell us, and how concerned should we be?
Zacharia: Remember, this number is an average of 10 different supply chain risks. So this is a significant number because, on average, what you're seeing is that out of all those 10 supply chain risks, supply chain managers think there has been a significant increase in the economy as far as risk is concerned. And what is interesting is that this risk is greater than what people saw when COVID happened. So this is concerning, and this is something that businesses will have to take into account as they go forward.
Croft: In the third quarter LRMI, Economic Risk, for the second time this year, has set a new record for the highest risk index number we've seen in any category in any quarter in the two years you've been doing the index. In fact, Economic Risk tops the third quarter list at 90.72, the first time any category has risen above 90 so far. So let's take a closer look at that. To start, what factors go into Economic Risk?
Zacharia: The Economic Risk index is asking supply chain managers about increasing energy costs, commodity price volatility, labor shortages, sudden demand shocks, global energy shortages, and border delays. And as you can just see with that listing, all of those areas in the economy have been significantly impacted with what's happened in the last quarter with all the things that you talked about. So clearly Economic Risk has significantly increased.
Croft: What are the main concerns regarding Economic Risk that you heard from the supply chain professionals participating in the index?
Zacharia: I think that the real thing—and I think this is something that is not apparent—is that the Economic Risk is particularly high because demand is decreasing at the transportation level. Transportation is always a leading indicator of what's happening in the economy. When the demand for trucks goes down, then you know that the economy is slowing down because not as many factories are actually shipping product, not as many retailers are bringing in product.
And here's an interesting statistic that just came out: A container price to ship from China to the U.S. was $15,551 in April. And two months later, it went to $9,177—a 40% drop. What clearly this means is that all the big container shippers, in this case usually big box retailers, they’re pulling back. They’re cutting back on the demand. So what this means is that there is going to be a significant decrease in demand going forward. And as I mentioned earlier, there is going to be excess inventory.
[When] you have the situation where you have too much inventory and not enough demand, then you are going to have significant decreases in prices as retailers start to try and unload that product. One of the things that supply chain professionals are talking about is that, for example, there is definitely a decrease in trucking demand. They’re seeing two kinds of things happening at the same time. You still have increased operational costs, like labor costs, but reducing demand means that they’re sort of going in opposite directions, and therefore, that really does increase the risk of not being able to meet your payroll or have enough to break even because clearly raw material costs, lead time, those are all increasing. And that's all a function of the war in Ukraine, that has an impact on fuel and material prices.
The Ukraine conflict is significantly impacting the supply chain across the entire world. And so as you continue to have this price volatility, you are going to have increased Economic Risk. And this is going to be a major problem in this upcoming quarter, and maybe the quarter after that.
Croft: As we look ahead to the third quarter, are there any other trends you've spotted in the latest LRMI report that we should be aware of?
Zacharia: As I mentioned earlier, and it's shocking, the container demand price has gone down by 40% in the last two months. This really indicates that the big box retailers, the people who are constantly shipping in products, see a real softening of demand in the economy. They're all predicting there's going to be a decrease in demand. People are going to become very concerned with inflation, and they're not going to buy as much product. And the U.S. economy has been saved by the consumer so many times. And I think that's a little bit scary.
If everyone is predicting the consumer demand is going to go down, that's going to affect the entire economy. So there's a really good chance that we're going to be headed in for a recession. Whether the feds can actually make that a soft landing, I don't know. But I think the overall thing that you have to think about is that if everybody is predicting that there is that much excess inventory, there's probably going to become some significant price cutting, and you're going to see some good sales and significant discounts for products, where, for the last little while, we've just been seeing increasing prices and increasing product unavailability.
And now you're going to see these products come in, and then they're going to sit there. And you're going to see some real movement to get those products out. So I think it might be worthwhile to hold off on some of your big purchases because I do think that some of that pricing is going to come down.