About the author: Christopher S. Tang is a University Distinguished Professor and Edward W. Carter chair in business administration at the UCLA Anderson School of Management.
The Covid-19 pandemic exposed Americans to severe shortages of toilet paper, paper towels, PPE, and semiconductor chips in 2020. In 2021, the supply chain crisis at the twin ports of Los Angeles and Long Beach is caused by shortages of workers at the ports, truck drivers, containers, chassis for truckers to haul containers, warehouse operators, and warehouse space.
In late October, 100 container ships were waiting at the twin ports, carrying nearly 500,000 containers of products. These shipping delays will create additional shortages of toys, shoes, and game consoles for holiday shoppers.
Is America running out of everything? Are there investment opportunities to meet these unmet demands?
The answers and no, and yes, respectively. But before jumping on the bandwagon, make sure you are not chasing the short-lived demand caused by the bullwhip effect.
The bullwhip effect is a supply-chain phenomenon. It describes how each link of the supply chain responds to a spike in demand by ordering more than necessary to hedge against potential continued growing demand and to avoid stockouts.
Experiencing higher consumer demands, retailers order more from distributors. Observing a higher order quantity from retailers, distributors order even more from the manufacturers. Because of the bullwhip effect, the order quantities observed by the manufacturers usually do not reflect real consumer demand.
During the pandemic, it is true that consumers have bought fewer services and more goods. Because of the bullwhip effect, the increased consumer demand amplified order quantities placed by U.S. manufacturers to overseas suppliers, triggering a surge in container ships arriving at all major U.S. ports.
But once the pandemic is under control, consumer demand will shift back from goods to services. Consumers will want roughly the same amount of goods they did before the pandemic. It is risky to make speculative investment decisions based on signals consumer demand that were distorted by the pandemic.
Investors need a clear understanding of the market dynamics. And there’s some good evidence that those market signals are not being correctly interpreted.
Consider the ill-fated investments in face-mask production in the U.S. The severe shortages of N95 masks in the U.S. in 2020 created investment opportunities for domestic production. When the number of Covid-19 cases peaked in January 2021, the orders for U.S. mask manufacturers went through the roof.
But after China began exporting more PPE to the U.S. in December 2020 and after the CDC eased mask mandates for vaccinated Americans in May 2021, the orders for American-made masks vanished. By August 2021, Miami’s DemeTech had laid off 1,500 workers in its mask division and was stuck with a stockpile of nearly 200 million masks.
The American Mask Manufacturer’s Association estimates that up to 10 out of 29 domestic mask manufacturers had stopped production as of mid-September. To prevent these manufacturers going bankrupt, the group is appealing to President Biden for government support.
Americans needed the domestic mask-manufacturing sector during the crisis. But their business models are not sustainable. The mismatch in supply and demand for American-made masks was short-lived partly due to the underlying bullwhip effect as well as the temporary suspension of export for PPE from China.
Two considerations will help reduce the risk of speculative investments.
First, relative to many low-cost manufacturing countries in Asia, U.S. manufacturers are not competitive in terms of cost. Instead, domestic manufacturers should compete on agility and flexibility. Because domestic manufacturers can monitor real demand up close, they can gain a competitive advantage over foreign suppliers if they can respond to the changing needs quickly and accurately.
Critical sectors such as PPE must develop supply-chain visibility to observe real consumer demand if they are to mitigate the bullwhip effect to contribute to domestic resilience and responsiveness. At the same time, this sector must possess agility so that it can produce regular products such as clothes in normal times and pivot quickly to produce PPE during a crisis. Having the capability to observe and respond to the real changing needs is key.
Second, while demands for PPE are short-lived, it is less risky to invest in areas that are experiencing sustainable demand growth. For example, many consumers shifted to online shopping during the Covid-19 pandemic, and e-commerce is expected to continue its growth over the next few years.
U.S. retailers are likely to shed retail space. At the same time, they need more warehouse spaces to process their customers’ online orders. The demand for warehouse space is growing. The U.S. warehouse vacancy rate has fallen from 4.3% in 2020 to 3.6% in 2021.
The commercial real-estate firm CBRE reported that the U.S. still needs an additional 330 million square feet of warehouse space to handle the increasing e-commerce demand. As demand for warehouse space is likely to continue in the post-pandemic era, investing in commercial warehouse space looks more promising.
To find a diamond in the rough during the pandemic, a deep understanding of the real market dynamics is critical—even more than normal times.
Guest commentaries like this one are written by authors outside the Barron’s and MarketWatch newsroom. They reflect the perspective and opinions of the authors. Submit commentary proposals and other feedback to [email protected]