It’s Labor Day weekend in the US and Rosh Hashanah is on Tuesday, so you might not be thinking about Christmas and Hannuka just yet...
But maybe you should.
If you are in the habit of exchanging gifts during these holidays, this might be the year of early planning. How early? Right about now.
Bloomberg has been reporting on shortages of products for quite some time and also reported recently that The World Economy’s Supply Chain Problem Keeps Getting Worse. For example, Christopher Tse, CEO of Musical Electronics, a Hong Kong-based firm which makes consumer products from Bluetooth speakers to Rubik’s Cubes, is quoted in the article saying:
“We can’t get enough components, we can’t get containers, costs have been driven up tremendously.”
I have covered the component shortage for electronics in great detail before, so I will refrain from repeating myself. Suffice it to say that it has not become better.
But I would like to devote more time today to another element of this statement: the container shortage.
Bloomberg had several articles on the factors behind these shortages. It's clear that two things happened simultaneously: significant delays at ports (driven by both port congestion and weather-related port closures) and significant price increases in shipping via containers.
How expensive have things gotten? Drewry, a firm that follows this industry, reported on September 2nd that “Drewry’s composite World Container index increased by 1.7% or $170 to $9,987.27 per 40ft container.” That is 344% higher than the equivalent week in 2020. This is the 20th consecutive week of increases. The prices on most routes from China to the US have increased by more than 400%!
So, my goal in this post is first to explain why we are seeing such an increase in prices (and how it’s related to the ports) and then estimate the impact on you, the gift bearer.
What Drives the Price Surge?
There are multiple factors driving the price surge of container shipping. The first is, of course, the increase in demand. Overall, consumer spending has increased due to numerous reasons, and demand for consumer electronics, cars, etc., has increased quite significantly.
But this is unrelated to the delays at the ports. My claim is that the congestion and slow turnaround times at the ports directly impact these price surges.
To understand why, I will describe a simple model. The goal of this model is not to be precise but rather to illustrate the connection between port delays and the prices of container shipping.
So, let’s do some math to start off the Holiday week!
To keep it simple, I am going to focus on a single route: China to LA.
And to simplify further, I will assume that containers on this route only travel back and forth between these two ports.
An average container would be loaded e.g., in Shanghai, will be on route to LA, wait at the port, get unloaded and loaded again (if needed), and travel back to Shanghai, China.
So let's try to estimate how many containers are in this route. We first need the number of containers shipped monthly (or daily) between these two locations.
Bloomberg has already reported that, in the Port of Los Angeles, the number of container imports totaled at 467,763 TEUs (Twenty-Foot Equivalent Units) in June. In an effort to simplify our model even more, let's assume that the total amount is coming in from China. If we divide by 30 days (to reach the daily load) and round off for simplicity, we get about 15,000 containers per day.
In trying to understand how many containers are processed on this route, we will use my favorite equation: Little's Law.
Little's Law in Operations is what Newton's Second Law is in Physics, or more. It's the E=MC^2 of Operations. Little’s Law states that the average inventory of a process (we will use I) equals the product of the throughput rate of the process (we will use R) and the average time a unit spends in the process (we will use T).
I = R T
In our case, inventory (and I use the term more broadly as a count of flow units) is the number of containers in this “system”. The throughput of the process is the number of units shipped per day (in our example 15K), and the average time includes the time along the different nodes or arcs of the process (time spent at sea and in ports).
We have already computed the throughput, so next we need the number of days. Based on different reports, containers now spend 7-8 days at each port, which averages to 7.5 days. I am also assuming that the time along the route (15 days) remains the same. We must keep in mind that all of these are assumptions. Are they accurate? Probably not. Are they helpful in getting some estimates? I sure think so. Again, the goal here is not to be precise but to offer a model that can explain the issues while staying open to criticism and sensitivity analysis.
Taking everything together, we can estimate the number of containers on this route for a round trip as follows: 15K * (15 days + 15 days + 7.5 days + 7.5 days) = 675K.
Based on our calculations, we can safely assume that the number of containers on this route is 675K.
It's not a far-fetched assumption that this number is fixed. Containers can be diverted from other routes such as Europe and may cause fluctuations, but let's treat this as a set number. In many ways, this could be the capacity of this route.
Now let's compare with pre-Covid days, where turnaround at ports was approximately one day.
We can then use Little's Law again (and believe me, it's addictive, so use it with caution) and rewrite as follows:
R = I/T, which is 675K/(15+15+2) and gives us approximately 21,000 containers per day.
So, the actual capacity to ship from China to LA went down from 21K to 15K, which is a 30% decrease in shipping capacity.
Couple that with the 27% increase in demand, and we can see where the overall price increase is coming from. Prices are not linear in demand. The fact that prices increase so much demonstrates that the willingness to pay for available capacity is quite convex.
To summarize, as port delays driven by congestion or Covid related stoppages increase, fewer containers will be able to travel on sea, which will drive prices even higher.
What will the Impact on Prices of Products be?
Given the long delays, if you plan to order toys or home furniture as gifts, you should consider ordering these now.
But you may also be curious about what the impact on pricing will be.
At this stage, many of the prices of the products are still not capturing these higher shipping costs.
But if we want to try and estimate the price, we could use the Total Landed Cost (TLC) model. The idea is that when looking at the cost of a product that you purchase or manufacture in another country, you have to account for all costs along the route, from manufacturing to shipping, to tariffs and inventory costs. I cover this idea in detail here.
But for now, let's look at a simple example of a toy that initially costs $30, for example. The traditional shipping cost of such a product was approx. $2 per unit. Considering the overall increase of shipping costs (around 300%), we would have to calculate an additional shipping cost of $6 per toy. So, a product of $32 TLC, will now cost $38, which does not seem like a huge increase.
But what about furniture, where the manufacturing cost may easily be $200, with a shipping cost of say $50? If the TLC was around $250 before, it could easily rise to $400 following the increase in shipping cost. I don’t expect customers to absorb all of these costs, but they will absorb the majority, as availability will be limited.
This is not only a US phenomenon. We see an even more significant price increase in Europe which can be explained by the fact that capacity on the China/Europe route is decreasing as more cargo containers are diverted to the US/China route. This would explain fluctuations in the 675K container capacity we previously calculated from Little’s Law.
A Credit Suisse Group AG poll published last week found that “approximately half the Swiss companies said they’d adapted their supply chains, up from one in three firms surveyed a year ago.” Around 18% said they were purchasing more within Switzerland, not a place known for its low-cost capabilities.
And the end's not near. We will see more disputations over the next few months, primarily as the weather remains unstable and Covid continues to create a lot of uncertainty. And as I discussed before, the government is not doing enough to reduce this uncertainty.
So, make sure you start your holiday shopping early this year! And if you are worried about your impact on congestion: order from a local manufacturer that sources everything near you—the “farm-to-table” equivalent of holiday gifting.
If you are involved in this supply chain either as a consumer or a supplier, I am curious to hear your thoughts about the impact you see.