According to possibly the most widely circulated statistics of early 2024 – courtesy of Lloyd’s List – 17,000 ships usually pass through the Suez Canal a year, carrying an estimated $1trn of goods and accounting for 12% of global trade.
Except that, thanks to the ongoing crisis in the Middle East and attacks on shipping in the Red Sea, only a fraction of this trade is currently using this vital trade short cut between Asia and Europe.
With ships increasingly taking a very long route around South Africa and the Cape of Good Hope, the knock-on impact on global trade and the world economy is self-evident.
Speaking in the wake of air strikes against Houthi rebel positions in Yemen, Marco Forgione, director general the Institute of Export & International Trade (IOE&IT) explained the precarious situation, with particular focus on how it is already affecting manufacturers:
“The manufacturing sector is at particular risk, given it operates on a ‘just in time’ process. A significant proportion of different components, commodities and ingredients all come through the Suez Canal, and if these are being delayed then this will feed through into the ability of manufacturers to maintain the production of goods. We can expect more warnings like those this week from the likes of Tesla if things don’t change.”
'Real world consequences'
Forgione added the situation was being made worse by further restrictions on the Panama Canal:
“These are real world consequences for business and for consumers, happening now and being compounded by restrictions in the Panama Canal, another vital global trade route.”
The Pamana Canal is just as important as the Suez Canal for shipping, as the Latin American route also carries $270bn in trade every year.
Throughout 2023, authorities have slowly been putting more and more restrictions on the canal, restricting the number of ships that can travel through and creating a sizeable backlog of vessels waiting to make the trip.
This has created a singular crisis for the world trade network, as two of its most important chokepoints are now operating under heavy restrictions.
So, what are the real consequences for manufacturers of the situation remaining in its current state or deteriorating further? And how did manufacturing supply chains get so complex in the first place?
Prof Jan Godsell is dean of Loughborough Business School and, after a career in manufacturing, including stints at ICI and Dyson, is an expert on global supply chains. This, she says, is a problem with long roots.
Supply chain shift
She points out that in the 1980s, major manufacturers typically had fully integrated supply chains, often owning everything from the source of raw materials through to the means of distribution to customers and even end users. Where practical, as much of this supply chain and as much of the manufacturing as possible was in-country or in-region, so goods were produced as close to the end consumer as possible.
There was then a shift as businesses started to take advantage of low-wage, low-cost manufacturing in the far east. “We realised we could potentially have global manufacturing of finished products and use low-cost logistics to move products around,” she explains.
For larger, more complex products such as cars, this meant key ingredients or components being sourced globally with regional assembly and local distribution.
“Jaguar Land Rover, for example has manufacturing plants in China, the UK, the Americas and so on,” says Prof Godsell. “A lot of what drove this was efficiency gains. You don’t need to produce everything in every country. This is a compromise between moving finished products or moving raw ingredients.”
Non-essential goods
Global production benefited from goods being produced in low-cost countries. Prof Godsell suggests this is typical for goods such as electronics, domestic appliances and toys, that are non-essential consumer goods.
“These aren’t things that are essential to life. They are ‘nice to haves’. The rationale for this is that we can produce them more cheaply and make better margins. Items that are more essential to life, still often have more regional manufacturing.”
But there are some downsides to this. Some of which recent events in Panama and the Red Sea are highlighting. Prof Godsell warns businesses have lost sight of both the risks and the reality of the costs involved. As she says:
“We have always known we need to consider the ‘total landed cost’ of something, which is a combination of many costs. The two predominant ones are manufacturing costs and logistics costs. But tariffs and not-tariff trade barriers also come into it.
“What tended to happen is that the cost of labour was such a large percentage of the cost of production that we started using labour cost as a proxy for manufacturing cost. Because the oil price was stable and low, and logistics costs were therefore low, we forgot about the cost of logistics.
“That continued right up to 2008, and the global economic crisis. Then suddenly, we saw the cost of oil massively rise. That forced us to start thinking about the total landed cost again, and we started to get a more balanced view of logistics costs versus manufacturing costs.”
Rethink
Prof Godsell says this was a moment that businesses started to focus again on supply chains and logistics costs and to really think again about the total landed cost.
“Fundamentally, for many supply chains, the organisations at the front are large global multinational companies listed on stock markets. As a result, they’re subject to a lot of financial scrutiny, which means they want reduce any working capital and have the best possible return on capital employed.”
This in turn means they have a tendency to reduce spare capacity in the system, whether that be inventory of finished goods, raw materials or spare manufacturing capacity.
“Essentially, this very financially orientated model has driven out all buffers from supply chains. It's also driven them to have quite exploitative procurement practices. Again, that desire to be as cost effective as possible means that procurement has been driven by gross margin. Procurement has become the dominant function with teams trying to push all the cost and all the risk down the supply chain.”
Rather than reduce risk, Prof Godsell warns that this can actually have the opposite effect, as risks re-coalesce in lower tier suppliers used by lots of companies in a sector.
“If you look at what's happening with the Red Sea and the Panama Canal, and last year with shipping through the Rhine – where water levels dropped to such a level that they couldn’t use it – it will mean shipping has to reroute and in the long term that will put up logistics costs.
“Being at sea for another four weeks means additional fuel. Secondly, it takes capacity out of the network, because everything that you've got is going to take longer to move. It means the world can move fewer goods.”
As logistics costs go up and lead times will get longer, companies will have to adjust, but some will also have to pass on costs in increased process. Prof Godsell takes the example of a high-street fashion brand:
“It's not good news for Next, for example, in the short term. If a season’s stock doesn't arrive on time they’ve missed the selling window for it. They are going to have a lot of stock write offs, or will have to reduce things to get people to buy them out of season. But it would only be a one-season effect.
“Once this is a known problem, they can replan to build in for the longer lead time and for future seasons they might even resource from other locations that reduce the need to use those shipping lanes.”
She adds that there may indeed be a boost in nearshoring, as more companies look to shorten supply chains and rely less on these now risky routes.
“We may see a move back to in-region production to mitigate the risk of having to ship. That could possibly be seen to be a positive thing. It would help to counteract the increase in logistics costs from shipping from a long way away if there's reduced capacity.”
Environmental concerns
On an even longer-term basis, Prof Godsell questions whether some of these logistics challenges will feed into the environmental campaigns to go green and consumer less.
“One of the things we need to recognise potentially is, whether we like it or not, we'll start to see questions over this whole consumption-driven approach to economic growth. We need to rethink. Perhaps this is a wake-up call for us to be more mindful about what we really need.
“Maybe manufacturers and branded goods organisations need to think about their business models and how they're still how they're still economically viable in a world that supports that type of approach.
“There has been a continual buildup of small things where people realise that supply chains are fragile, and this model of globalization may not be the best one. At the end of the day, if we don't have the latest season’s T-shirt, it's not going to be life changing. If we don't have food or pharmaceuticals, if we don't have energy its different to if we don't have the latest Range Rover.
“But organisations at the head of the supply chain have a responsibility to think about their business model and the future, and definitely for products like domestic appliances and other items where they can be repaired, refurbished or remanufactured, we should be looking at models like that.”
