Why the DPA Won’t Cure Covid-19’s Supply Shortages
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U.S. factory activity declined in February as new orders contracted and concerns about coronavirus-related supply chain disruption spread across industries. The Institute for Supply Management’s PMI is clinging to expansion at 50.1 percent, down from 50.9 percent in January.
Fifty is the line of demarcation between expansion and contraction.
“Coronavirus is wreaking havoc on the electronics industry,” a tech executive told the ISM. “Companies are delayed in starting up production, which is resulting in longer lead times, constraints and increased pricing. It's a mad dash to dual source stateside in case China isn't back online soon.”
Chinese factories – which were scheduled to resume production the first week of February following the Chinese New Year – are suffering from a severely-reduced workforce. Workers that went home for the holiday have not yet returned to their jobs due to quarantines, road closures, transportation restrictions and a lack of medical gear. As of mid-February, only 30 percent of China’s workforce had returned to work.
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Three of the five sub-indexes that support the PMI fell in February, led by the biggest drop in production since 2018. New orders decreased 2.2 percent to 49.8. Production reached 50.3 percent, down 4 percent from January.
Order backlogs increased 4.6 percent to 50.3 percent; employment grew 0.3 percent to 46.9 percent; and supplier deliveries hit 57.3, up 4.4 percent.
Overall, 50.1 indicates that manufacturing activity was level with January’s pace, said Tim Fiore, chair of the ISM's manufacturing survey committee. Top sectors of the U.S. economy – including electronics and chemicals—performed about the same. However, sub-indexes, manufacturer commentary and business sentiment have changed dramatically from January.
Coronavirus-related commentary leapt from 2 percent in January to 43 percent last month. Roughly 20 percent came from manufactures that are already experiencing supply chain hiccups, Fiore said; the rest are companies that anticipate supply problems. Executives expressing positive sentiment toward the economy dropped by half between January and February.
Imports -- which dropped 8.7 percent to 42.6 in February – reached their lowest level in a long time. Inventories registered 46.5 percent, 2.3 percent drop; prices registered 45.9 percent, down 7.4 percentage points; and new export orders decreased 2.1 percent to 51.2.
“To me, this indicates that everybody is struggling to figure out where their BOM is being affected,” Fiore said. “How much inventory they need to keep on hand – although we also see prices collapsing. Those that have inventory are selling it at lower prices. It’s driven by the economy. Customer inventories got worse [in February] but production couldn’t keep pace, so the logical conclusion is they didn’t have everything they needed so they delivered what they could.”
The industry is seeing constraints—not getting the material they need at the right time--and that’s ominous, he added. “Imports are already low and we just see it getting worse.” (The supplier deliveries and inventories indexes directly factor into the PMI; the imports index does not.)
“The PMI remained in expansion territory, but at a weak level,” Fiore added. “Demand slumped, with the new orders index contracting at a weak level, despite new export order expansion; the customers’ inventories index remaining at ‘too low’ status and the backlog of orders index expanding for the first time in several months, but at a slow rate.”
The ISM was projecting the factory index would hover around 50 until the U.S. presidential election in November. “We’re not saying that anymore,” Fiore said.
Another U.S. factory gauge, produced by IHS Markit, fell to the lowest level since August. February's index dropped to 50.7 from 51.9 in January.
Economists are now weighing in on Covid-19 after a “wait-and-see” period. “As the coronavirus shifts from a regional epidemic to a worldwide pandemic, supply chain issues are going to grow exponentially. Despite concerns about the spread of Covid-19 to dozens of countries, for now China remains the most seriously afflicted,” said University of New Haven Professor Patrick Gourley, Ph.D. “Given China's role as the world's producer, even if the virus stays mostly contained within its borders many industries are at risk.”
The true problem, he added, is far worse. “Not only is China involved in the production of many final goods, but they produce many intermediate goods that are then sold to a second country before coming to the United States. For many American firms, their production process is an opaque network of contractors and subcontractors. Exactly who is involved in a production process from start to finish might involve four countries and a dozen firms.”
The spread of the coronavirus has become an economic threat, economist Robert Genetski, of Classical Principles, told the ERA Executive Conference last week. “Investors are scared, doctors are scared and we’ve recently seen sharp increases of the infection outside of China.” However, he added, 80 percent to 90 percent of people who get the virus recover and a low number of fatalities have been reported. “I would say based on the data it seems China is getting this thing under control. The question is, how long will [Chinese] operations be down?”
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Mitigating risk is always the job of of a well designed supply chain. Whether it be tariffs that drive up costs or pandemics that disrupt supply we should always strive to keep our options open, to increase flexibility and have contingency plans.
Just bringing manufacturing back to your home country does not necessarily solve problems as the US is likely to have towns and business quarantined and people told to stay home as was/is the case in Milan and Wuhan.