Understanding current inflation demands understanding the supply chain

Despite the hopes of some economists, bottlenecks in the supply chain will remain and contribute to inflation, writes Levin Holle, chief financial and logistics officer at Deutsche Bahn

Inflation is back and the supply chain is the culprit.

In Europe and North America, more than a decade of stable prices, low interest rates and high real wage growth has come to an end.

Central bankers, policy-makers and households are having heated debates over what to do in this new environment. So are we at Deutsche Bahn, Germany’s national railway company. We need to find answers to the same questions as any enterprise, state or privately owned. We are set to invest €13.6bn in our rail infrastructure in 2022. Our 2.6bn passengers expect stable prices and reliable service. Meanwhile, our 338,000 employees are seeing the purchasing power of their wages melt away.

What do we know about the current inflationary pressures? Its two main causes have already been identified: energy price increases and supply chain shortages.

DB Schenker, our logistics division, has been able to secure transport capacities and keep supply chains running throughout the pandemic. In 2021, DB Schenker operated more than 2,300 flights in response to the shortage of freight capacity and ran more than 100m overland shipments. With the largest transport network in Europe, it was able to overcome many of the enormous challenges for supply chains and logistics posed by the Covid-19 pandemic. Nonetheless, the global transport markets are far from their pre-Covid-19 situation.

In 2019, it took roughly 35 days for a shipping container to go from Shanghai to Los Angeles. This includes all stages of transport, from empty pickup at a depot in Shanghai until its empty return to a depot in Los Angeles.

Today, the same trip takes 61 days. Manufacturers or retailers may be able to adapt to longer delivery times, if they remain predictable. But 24 additional days of transit for one shipment results in a shortage of containers no one has been able to compensate for. This supply side shock has shaken the global transport market.

In April 2020, more than 16,000 passenger aircraft – roughly two-thirds of the global fleet – were grounded, following travel restrictions imposed by governments across the globe. In normal times, these passenger airplanes carry more than 50% of global air cargo in their bellies. Until May of the same year, ocean carriers too were slowly reducing transport capacities out of the far east due to factory closures and expected production delays in China amid its first Covid-19 wave.

Compounding this sharp decline in capacity, demand for transport and goods out of China soared. Europe and North America urgently needed medical supplies and home office equipment. Governments issued huge stimulus packages, while families stayed at home and shifted their spending from consumption at cinemas, restaurants or hotels to investments in furniture, bicycles, garden tools and other durable products. As factories in the far east resumed full operation, carriers struggled to provide sufficient capacity.

Covid-19 highlighted another well-known problem for global supply chains: port congestion. Containment measures, such as social distancing, reduced workforces and new hygiene obligations like mask wearing, slowed down ground and port handling operations significantly. Some of the world’s busies ports, such Ningbo near Shanghai and Yantian in Shenzhen, were at times shut down almost entirely.

Ports with a low degree of automation and high dependency on human labour, such as Long Beach and Los Angeles in the US, were hit hardest. Even today, around 70 container ships with more than half a million containers on board are queuing off the coast of California. On top of this comes a lack of truck drivers in both Europe and the US. And, of course, there was the Suez canal blockage after the Ever Given, one of the largest container ships in the world, ran aground in March 2021.

Currently, only 33% of container ships reach their destination on time, compared to roughly 80% before Covid-19. The average delay has almost doubled to roughly seven days. 12% of all goods at sea are on ships that are currently not moving anywhere, according to the Kiel Trade Indicator. On ships outside only four major shipping locations, Long Beach/LA, the Pearl river delta, Ningbo and Savannah, sits 5% of global container capacity.

‘Freight rates, in some instances, have climbed 1,000%’

We have moved on from a time when logistics and transport capacities were easily and always available and the contract for transport was awarded to the company that offered the lowest price.

Today, it is the other way around: ports are clogged, transit times have increased and capacities are scarce. Freight rates, in some instances, have climbed 1,000% and the logistics provider who can guarantee secure transport capacities despite all these disruptions wins the contract.

Large forwarders with sufficient cash flow can cope by setting up their own air cargo operations and provide reliability and flexibility through multiple carrier contracts. But smaller forwarders struggle massively. There will be a further acceleration of the current race for consolidation and mergers and acquisitions in the logistics sector.

A second major challenge has almost retreated to the background, although it is the bigger one. How can supply chains to become green and carbon dioxide neutral? Deutsche Bahn’s goal is to be climate-neutral by 2040. But we must be honest and say that there is a gap between our goals and what is feasible today. We must close this gap step by step.

One important target in our home market, Germany, is to move 25% of all cargo by train. Another approach is to invest in scaling up synthetic green fuels, such as sustainable aviation fuel or green methanol for ocean freight. We are ready to make a clear commitment to help scale up production by having clear and stable demand from us.

In the short term, these ambitions will reduce capacities on the transport market, for which we will need to be prepared. From January 2023, the entire maritime fleet will have to comply with more restrictive emission regulations established by the International Maritime Organization.

As a consequence, most of the 6,000 container ships worldwide will have to go to a dry dock to be refitted to reduce carbon dioxide emissions. Any growth of the global container fleet in the coming years will be offset by these requirements.

On top of this, most of the vessels will have to reduce their speed to meet the new requirements. More ships would be needed – but are not available – to maintain weekly frequencies on important trade lanes.

This illustrates that the inevitable changes we must make to reduce emissions and reach our zero emissions target come at a price.

In the foreseeable future, supply chain costs will rise more significantly compared to the overall production cost of any good that is not locally produced. We can no longer take logistics for granted.

‘There is one obvious thing governments can do to help alleviate the situation: invest in infrastructure.’

Policy-makers’ recognition of the importance of functioning supply chains was reinforced by images of their voters standing in front of empty supermarket shelves at the height of the pandemic.

There is one obvious thing governments can do to help alleviate the situation: invest in infrastructure. The most severe disruptions to logistics operations originated in ports, not at sea. The Suez blockage was a special case. But it showed, too, that there was a lack of redundancy in the infrastructure. If one bottleneck is blocked, alternatives are limited. A functioning logistics sector is a strategic asset for any economy. The Chinese government has understood this, investing in its belt and road initiative. Europe and its western partners have not displayed a matching ambition. When we talk about free trade, we should not forget that we also need to control the equipment and infrastructure that carries it.

Consolidation in the logistics sector has accelerated, driven by recent high profits and cash reserves generated by carriers and forwarders in 2020 and 2021. Carriers are increasingly investing in vertical integration, thus challenging the position of forwarders. Today, after decades of overcapacities and fierce competition among shipping lines, there are only seven large carriers left. Forwarders, however, offer the flexibility and choice that industry needs to get products to destination in time.

There is a need for open, transparent political dialogue on climate targets and the way to reach them. What can we achieve today? What doesn’t work yet? Where do businesses need to receive support? Europe has the ambition to drive the global transport shift. To get closer to this target, the most promising and significant step would be an integrated European investment plan for rail infrastructure.

None of these efforts will bring relief for the strained global supply chains in the short term. Nor does the outlook for logistics in 2022 promise a swift return to pre-Covid-19 conditions. The urgent need to act on climate change only adds to the challenges we have seen since the outbreak of the pandemic.

On top of this come the consequences of Russia´s invasion of Ukraine. Sanctions, the closure of Russian airspace and the severing of other transport links will add to existing problems. Many companies will have to reconsider production sites, sourcing partners and transportation routes against a fundamentally changed geopolitical outlook.

While many economists proclaim supply chains as the major, but short-lived, driver of recent inflation, looking at them reveals that challenges are here to stay.