May 10, 2022

Q2 2022 Market Watch: Dual Inflation Threatens Growth and Margins

Inflation is applying pressure to both sides of the supply and demand equation.

Market Watch Collage May2022

Costs continue to rise as retailers and brands grapple with how to manage higher priced inputs while still growing top line revenue.

Key Takeaways

  • Consumer price inflation reached a 40-year high in March, growing 8.5% year-over-year
  • Semiconductor shortages resulted in $500 billion worth of lost revenue
  • Plastic resin prices, used in CPG packaging, jumped by 50% last month
  • The average fuel surcharges among major LTL carriers skyrocketed from 28.3% in Q4 2021 to 42.1% in March 2022
  • The national average rent for industrial space hit $6.45 per square foot

In addition to production delays, transportation issues, and labor shortages, supply and demand-side inflation add another challenging wrinkle for retailers, brands, and consumers.

Organizations face higher input costs, while simultaneously grappling with inflation’s impact on demand.

As a result, companies across all verticals and geographies are navigating ways to protect growth in the face of inflation and its effects.

Inflation persists, increasing pressure for retailers and brands #

On top of the other challenges battering brands and retailers, the country is in the harshest inflationary environment in decades. The cost of everything, from the raw materials used to produce consumer goods to procuring the trucks, is rapidly increasing. To get a sense of the ubiquitous nature of rising prices, here is a deeper dive into specific inputs.

Semiconductors are costly and scarce #

Chips are a fixture of modern production. They are in everything from automobiles to household appliances. And the adoption of 5G tech is placing additional strain on producers due to the widespread scarcity of the coveted input.

The chip shortage has persisted throughout the pandemic. Once widely publicized, it’s fallen out of the headlines due to other more attention-grabbing issues affecting the globe. However, it’s still a genuine concern for manufacturers across sectors. Ford recently posted $3.1B in lost revenue over the past three months due to the scarcity.

But that figure is just a small percentage of the $500B semiconductor-induced losses since the start of the pandemic, and analysts don’t expect there to be enough supply again to meet demand this year. Currently, product lead times are six months or longer for those that need semiconductors in products.

Scarcity has also done more than increase production timelines. Along with broader inflation, it has driven semiconductor costs to new heights. Over the past year, prices have jumped by 15%, and analysts expect them to rise another 13.6% in 2022.

Food and beverage brands also see input cost inflation #

Manufacturers in the food and beverage space also face rising prices on production-critical materials. The fallout from the war in Ukraine and other global production disruptions has complicated an already-difficult situation for brands.

Fertilizer

Nitrogen fertilizer costs surged 43% to $1,625 in March due to war-induced scarcity. Farm bills will increase by 12% this year, which will undoubtedly affect consumer brands’ margins unless costs are averted elsewhere. Russia is the predominant supplier of all other crop nutrients and accounts for 20% of worldwide exports.

Packaging materials

China curtailed aluminum production and other energy-intensive metals last year as part of its plan to reduce carbon emissions. Surging natural gas prices in Europe have also pushed some producers to cut production, losing more than 650,000 tons of annual production capacity since the rise in energy prices began in October.

Aluminum producers have invested in new projects to ramp up capacity in the U.S. However, plants will take time to come online. Thus demand will continue to outstrip supply in the short term.

Similarly, plastics are feeling the pinch. Resins used in all plastics are in short supply again. The scarcity has caused a surge in pricing of over 50%. Increased costs in packaging material affect brands’ bottom lines.

Other inputs

The Indonesian government has also recently reduced the amount of palm oil available for export. The edible oil is the most widely consumed variety and used in many consumer products. The restrictions have driven up global edible oil prices. Its jump in price could further stretch margins for consumer goods manufacturers.

Nonresidential construction prices are up 23.2%. On top of other increasingly costly materials, higher construction prices will hamper companies’ ability to add permanent infrastructure like warehouses and fulfillment centers.

Logistics costs climb for shippers and retailers #

Along with input cost increases, transportation and storage rates continue their ascent. Because of this cacophony of costs, shippers and retailers are looking for efficiency-driven ways to control logistics spending.

Increases in fuel costs are the biggest reason for inflated rates. Despite last year’s climb, they will continue their upward trajectory in 2022. Diesel prices increased by $1 per gallon in just one month—an astronomical figure.

The average fuel surcharges among major LTL carriers skyrocketed from 28.3% in Q4 2021 to 42.1% in March 2022. Analysts don’t expect these to recede either. The LTL pricing index may reach an all-time high of 40.9% in Q2 2022 compared to the January 2018 baseline—a 4% quarter-over-quarter increase.

With LTL rates at historic highs, shippers are considering alternatives like shipment consolidation, multi-stop truckload, and additional warehousing solutions to help manage costs. However, warehousing is increasingly expensive.

The national average rent for industrial space hit $6.45 per square foot in February 2022, jumping 4.4% YoY. Lack of vacancies is a major driving force as the average industrial vacancy rate dropped to 5.2%, a 0.3% decrease over January’s numbers, in top U.S. markets.

Moreover, wage hikes in the sector hit warehousing acutely. Pay rates in warehousing and storage increased 4.4% YoY. These may continue to trend upward as the noted wage increases are still below inflation.

When combined with a historically tight market, shippers face higher logistics costs in almost every facet of the supply chain.

The only respite comes in the ocean shipping sector, where prices decreased by 3% despite outbreaks and lockdowns in mainland China. This drop may only be a temporary result of production shutdowns in the country. Rates will likely climb as the country returns from Covid lockdowns.

Inflation spills over to consumers #

Inflation is not limited to producers, providers, and retailers. Consumer price inflation reached new heights in March 2022 at 8.5% YoY. Additionally, the Consumer Price Index rose by 7.9% through February, the fastest annual inflation pace in 40 years.

Graph 2

Shoppers say they are cutting spending #

Higher costs are having an impact on consumer attitudes. In a survey conducted in March, shoppers say they plan to reduce discretionary spending. More than 50% of U.S. adults say they’ve already cut back on dining out and consider reducing that further if inflation continues to surge.

Graph 1

Furthermore, 50% of those surveyed said they think about rising prices all the time. And 55% of those with a household income of $50,000 or less are continuously looking at prices. Additionally, the survey found that disposable spending won’t be the only thing at risk if inflation persists. Consumers may delay home buying and car purchases.

Graph 7

This collective sentiment presents a risk to brands, logistics service providers, and retailers. With less overall spending, links in the supply chain may see diminished demand for the products and services.

Sentiment doesn’t always match reality #

Although consumers presented a gloomy outlook in the face of price increases, their attitudes don’t always predicate action. Spending in March did not slow despite the costs. Bank of America’s credit and debit card data showed strong growth, as aggregate card spending was up 11% YoY.

And data shows a strong April, too: Combined aggregate credit and debit spending is up 15% YoY.

Graph 8

This mismatch in expected and actual behavior makes it difficult for organizations to forecast spending and the need for supply chain services. Despite it, businesses are attempting to gauge how to maximize efficiency and margin accurately. Doing either incorrectly threatens top-line growth and profitability.

Market watch: The logistics industry month-over-month
#

To consistently monitor the logistics market, the Flexe Institute reviews key data points that illustrate critical industry forces.

Logistics Managers’ Index (LMI) #

This index compiles the responses from more than 100 supply chain professionals on the movement and direction of eight key logistics metrics, aggregated into a single index. The LMI provides an effective supply-side monthly snapshot. It dropped slightly from March’s record high numbers but remains elevated and trending toward growth. Moreover, warehouse capacity continues to tighten.

Graph 5

FRED | Real Personal Consumption: Durable Goods #

Durable goods consumption tells the demand narrative during a given period, predicting the need for logistics services. This month’s data shows that personal consumption continues to rise, contradicting consumer sentiment stats and inflation data.

Graph 3

Industrial Real Estate Vacancy Rate #

This composite vacancy rate effectively indicates warehousing capacity in the country at a given time. It acts as a barometer for facility rates and availability. The lower the rate, the more difficult it is to find space for warehousing, distribution, and fulfillment.

Graph 4

U.S. Manufacturing Purchasing Managers’ Index #

The index captures industrial output in the country during a given period. Like durable goods consumption, it provides context for demand forces: The higher the manufacturing index, the more volume will spill into the logistics market.

It has broader implications about the health of the domestic economy. Industrial activity is an effective indicator of growth. This month, the index fell for the second consecutive month, hitting 55.4—a 1.7 point drop from March’s numbers and the lowest level since July 2020.

Graph 6

Looking forward: How inflation affects parts of the supply chain #

Companies like P&G, Kimberly-Clark, Unilever, and Pepsi have offset skyrocketing fuel prices and supply chain disruptions by passing those costs onto consumers. But as costs continue rising, organizations may need to do more. Others, like Amazon, added a 5% fuel surcharge for fulfillment services for all its third-party sellers.

The concern about inflation is widespread. During earnings season, consumer goods CEOs mentioned inflation in 56% of calls, which is up by 11% from last year. While an inexact measurement, the topic is pervasive and many leading enterprises are aiming for ways to curb economic challenges.

To offset rapidly increasing costs without adding surcharges to partners or costs to consumers, organizations are employing supply chain strategies to increase efficiency, build resiliency, and preserve working capital.

Many shippers and retailers are redesigning their networks and placement of inventory due to demand channel variability / uncertainty. This approach allows them to more easily control costs and increase the efficiency of their network, reducing the logistics burden.

What it all means for shippers #

Inflation has remained far more persistent than anticipated, and until significant demand destruction occurs, prices will continue higher. Many enterprise shippers hold historically large and costly inventories.

While post-pandemic strategies aimed at increasing safety stock, a record-tight warehouse market may complicate these plans. Avoiding lost sales is critical, but inventory growth has led many shippers to purchase space in the most expensive market on record. It may be prudent to be more strategic with inventories and anticipate potential demand cooling in forecast modeling and purchasing.

What it all means for operators
#

Warehouse operators have found ample deal-flow in this red-hot industrial space market. Recent numbers have shown a slight softening in eCommerce growth, as mean reversion to brick and mortar retail has occurred post-pandemic. Further, inflation may dampen overall consumer demand, ultimately driving inventory expansion and growth in the warehouse market. Operators should look more closely at their current deal flow and balance long-term business (omnichannel) with the more transitory business caused by excess, slow-moving inventory. Despite record construction, however, it will likely be many months before a meaningful change in this record-tight industrial space market.

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