Manufacturing and Distribution: 2021 Overview and Key 2022 Influences

For many decades, U.S. entities have focused on growing their bottom lines by procuring both raw materials and finished goods internationally. Certain consequences related to this global trend have become readily apparent since the COVID-19 pandemic began two years ago.

Raw Materials

The availability of raw materials on a timely basis for use in the manufacturing process has been a given and led to the just-in-time (“JIT”) inventory system as this helped manufacturers manage their working capital. However, the JIT inventory philosophy has been abandoned by many entities due to the following factors:

• Reduction in production
  • Labor issues, environmental factors and other challenges in international markets have made it more difficult for U.S. entities to source raw materials.
• Container availability
  • The demand for containers has increased significantly in the last two years severely impacting availability. When available, the cost of containers has often skyrocketed. For example, containers from China have increased from approximately $3,000 each to more than $30,000 each. While there is hope for a moderation in prices, there have been limited reductions to date.
• Port limitations
  • The increased demand for goods transported by ship has increased. Combined with employee limitations, the length of time to ship products from overseas and have them offloaded at the ports has also increased significantly.
• Domestic logistics issues
  • The capacity of the U.S. transportation industry has been hampered by truck availability, driver shortages and certain state laws that have impeded the transportation of raw materials from ports to the manufacturing facilities.
• Employee shortages
  • COVID-related issues, the Great Resignation, poor labor participation rates and government incentives have impacted manufacturers’ ability to attract and retain qualified employees. These shortages arise despite an increase in compensation packages. This lack of employee resources is pushing employers to toward a more automated (i.e., robotic) workforce.

The common link among each of the above factors is that costs are increasing rapidly. When combined with tariffs that were reinstated as of January 1, 2021, U.S. inflation has increased to more than 6%, an impact that was contemplated by few companies at the beginning of the year. The importance of a company’s ability to timely adjust its inventory costing cannot be underestimated because it is key to properly adjust its own pricing to minimize the lag between cost increases and revenue increases.

Despite significant increases in product costs, many companies have chosen the option of building inventory levels and have abandoned the JIT inventory system. This alternative increases the demand of scarce resource in the short term and further exacerbates the issue of rising material costs.

Increased inventory levels have also impacted entities that have historically maintained limited warehousing space. This, combined with significant expansion in certain states by Amazon and others, has resulted in a soaring demand for warehouse space.

Despite significant challenges for many industries and businesses resulting from the pandemic, many manufacturing and distribution companies have been able to attain improved profit levels. Improved profits, extremely low costs of financing, and significant cash accumulations for private equity backed funds and other potential acquirers have created a large increase in deal flow—often at improved multiples. Potential acquirers are also sometimes able to benefit from certain companies, including those run by baby boomers, that have suffered through the fatigue and constant challenges of running a business during a pandemic.

Finished Goods

While the preceding comments were directed at entities that import raw materials, the story is very similar for those entities that import finished goods. The significant “outsourcing of the manufacturing floor” to foreign countries for many years has made the U.S. reliant on foreign production, including certain products in the health care industry. The reduction in the U.S. manufacturing industry makes it very difficult, if not impossible, for U.S. manufacturers to increase their production levels to meet the demands of American consumers, and this would require raw materials to be available domestically.

Heading into 2022

There are a number of key factors impacting the U.S. manufacturing and distribution industry including (1) the Federal Reserve’s announcement to have multiple increases in interest rates in 2022; (2) the uncertainty related to the President Biden’s Build Back Better (“BBB”) initiative given Senator Manchin’s recent announcement that he could not support the two trillion dollar bill; (3) The passing of the Infrastructure Bill; and (4) uncertainties regarding the entire global supply chain as COVID and its variants are expanding at an alarming rate. If interest rate increases are as expected, they would still be on the lower end of historic rates and should be manageable for businesses. As indicated in the BBB, a large amount of the incentives is targeted at certain industries (e.g., clean energy) and not necessarily aimed at the broad manufacturing and distribution industry. Uncertainty remains as to any potential replacement to or amendment of the BBB. The enactment of the infrastructure bill will should provide benefits to businesses providing these services. Finally, COVID’s impact is uncertain. However, there appear distinct opportunities for those entities properly positioned.