Industrial companies are making deals and investments to gain more control of raw materials and reduce potential disruptions.
Faced with rising inflation and a global supply chain that’s more akin to a game of Whac-A-Mole than an actual chain, companies are reaching for control where they can find it. For some, this has meant investing in more data tracking to get better visibility. There’s been a lot of debate about whether the pandemic disruptions and shipping logjams will inspire companies to shift manufacturing work closer to the developed-market end user — and there is some evidence that’s happening. But a growing number of companies are also deciding that if they want something done right in their supply chain, they might have to do it themselves.
Sherwin-Williams Co. on Friday reported weaker-than-expected preliminary fourth-quarter earnings, adding to a string of disappointments for the paint maker that it has blamed on supply chain snarls, inflation and labor shortages. A wave of extreme weather events that closed factories in the U.S. Gulf region last year limited raw material availability, exacerbating widespread logistics pileups. So Sherwin announced in September that it was buying one of its coating ingredient suppliers — Specialty Polymers Inc. — and its less hurricane-prone facilities in Oregon and South Carolina. Hershey Co., meanwhile, bought a pretzel manufacturer with three facilities in Indiana and Kansas to support its acquisition of the Dot’s Pretzels brand and reduce the potential for supply chain disruptions. American Eagle Outfitters Inc. acquired a pair of logistics companies to help it better compete with bigger retailers in offering customers affordable fast delivery. And steel producers including Nucor Corp., Cleveland-Cliffs Inc. and Steel Dynamics Inc. have been buying up scrap processors to ensure a steadier supply of raw materials harvested from junked cars and appliances, according to an analysis by the Wall Street Journal.
Automakers, crippled by semiconductor shortages and rushing to electrify, are taking a more direct role in sourcing chips and battery supplies. Ford Motor Co. launched a collaboration with GlobalFoundries Inc. under which the carmaker may buy directly from the chipmaker rather than through supplier middlemen that proved to be a weak link. Stellantis NV and General Motors Co. are setting up semiconductor design and development partnerships of their own, while SAIC Motor Corp. took a step further and invested 500 million yuan in an auto chip startup through its finance arm. Tesla Inc. reportedly even considered buying its own semiconductor plant at one point. GM and Volkswagen AG are also investing more directly in cathode-material factories and lithium supplies. Mercedes-Benz AG will build the powertrains for its next-generation electric vehicles in-house starting in 2024, replacing technology from existing suppliers, an executive at the carmaker’s parent Daimler AG told trade journal Automobilwoche this month. A handful of automakers are developing their own operating software, too.
“The rate of disruption that many supply chains in the industrial space are seeing is overwhelming the traditional resiliency strategies — that basic blocking and tackling of getting a second source or building a little more inventory,” said Joel Knox, a senior research director on Gartner’s supply chain strategies team who covers the industrial sector. This is motivating companies to think more proactively about eliminating possible risks from their supply chain. A logical extension of this process would be to fund vertical integration through M&A or invest in vertical infrastructure for new capabilities, Knox said in a phone interview.
This raises an interesting question of whether the largest manufacturers of industrial equipment may follow suit and bring more of their supply chains in-house. Companies such as Carrier Global Corp. and Honeywell International Inc. have said they’re also working more directly with semiconductor manufacturers than they have in the past. But other examples of vertical integration have been limited so far in this corner of the industrial world. Perhaps that’s because the executives seem more optimistic about the future viability of the supply chain models of the past.
Companies including Dover Corp. have said they’re over-ordering some components in the short term to minimize the impact of parts delays or shortages. But there hasn’t been the same kind of mental shift as in the automotive industry away from just-in-time manufacturing — a system in which components are ordered based on demand and arrive in a carefully timed sequence. In an August interview, Honeywell Chief Executive Officer Darius Adamczyk cast doubt on the benefits of maintaining a permanent safety surplus of components. Keeping inventories low “makes all the sense in the world and, as long as you can balance the supply and demand profile, it’s a very sensible way to run the business,” he said. Just-in-time manufacturing isn’t dead; “it’s sick,” Adamczyk said.
And for all the speculation about a rethinking of offshoring, plenty of industrial giants have continued to prioritize lower-cost locations. Interestingly, this group includes Rockwell Automation Inc. — a company that stands to benefit meaningfully from any pivot by others from low-wage manufacturing to automated production in the U.S. Emerging markets accounted for almost 60% of Rockwell’s factory footprint last year, up from 37% in 2011, according to an analysis by Melius Research’s Scott Davis.
That being said, there likely aren’t many savings left to be wrung from just-in-time manufacturing and offshoring strategies at this point. Companies will have to think more creatively about ways to extract value from their supply chains. A growing number of industrial manufacturing and services companies — from Dover to Carrier and trash-hauler Waste Management Inc. — have said recent labor shortages are motivating them to accelerate investments in automation. Relatively low levels of per-plant automation investment (less than $1 million per year) were linked to a 7% improvement in labor productivity, after controlling for industry and facility characteristics, Bank of America Corp. analyst Andrew Obin wrote in a November report, citing research from the U.S. Census Bureau. Those efficiency gains may convince some end manufacturers of large equipment that they can more productively make components that they used to buy from third parties.
For example, Raytheon Technologies Corp.’s Pratt & Whitney division is investing at least $650 million through 2027 to build a highly automated facility in Asheville, North Carolina, for jet engine airfoils, raising questions of whether it will depend less on existing suppliers such as Howmet Aerospace Inc. going forward.
For some companies, joint ventures and partnerships will make more sense than direct investment in or acquisitions of materials and parts suppliers. General Electric Co. agreed recently to collaborate with GM on setting up supply chains for rare earth materials and magnets as well as copper and electric steel — all of which are used to manufacture both automobiles and renewable energy equipment. But Knox of Gartner points out that strategic partnerships are notoriously tricky, particularly when cost savings are at stake for both parties. If the goal is more control, it can be hard to share. But whatever the form, it seems likely that this trend of taking more direct oversight over parts of the supply chain will continue.
Quote of the Week
“If we could pick a period of time for an omicron variant to surge, we would probably pick this time of year because I think it’s got two components that are unique. ... One is, these five weeks that it’s impacting are five of the lightest weeks in terms of business travel; and two, as you indicated, it has really impacted more the close-in demand than the further-out demand. And we believe we have plenty of time to recover those deferrals of vacation bookings for summer.” — Glen Hauenstein, president of Delta Air Lines Inc.
Hauenstein made the comments on a call with analysts this week to discuss the airline’s fourth-quarter earnings. A spike in Covid-19 cases linked to the highly transmissible omicron variant has forced companies to postpone a return from remote work, prompted tighter international travel restrictions and led some consumers to reconsider leisure trips. That’s tempering Delta’s near-term financial expectations, but the airline expects the pace of recovery to snap back to pre-omicron levels fairly quickly, starting with the Presidents Day weekend holiday in late February in the U.S. In total, revenue for the three months ending March 31 should recover to at least 72% of 2019 levels, compared with a 74% rebound for the most recent quarter, Delta said. The airline expects to lose money in January and February before returning to profitability in March and the full year. Omicron-related staffing shortages sparked a wave of flight cancellations during the holidays and are still creating disruptions but “it appears that the worst may be behind us,” Delta CEO Ed Bastian said. In the past week, only about 1% of the airline’s flights have been canceled for omicron reasons.
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Deals, Activists and Corporate Governance
Air France-KLM announced this week that it would start charging fliers a little extra to help cover the cost of using sustainable aviation fuel. Passengers will face surcharges of 1 to 12 euros ($1.15 to $13.74), depending on the distance traveled and the type of ticket they purchase. Business class fares will include higher fees. The aerospace industry has coalesced around SAF as the most viable near-term solution for reducing carbon emissions from flight, with innovations in electric or hydrogen engines for larger planes likely decades away at best. But the fuel — which is derived from cooking oils, waste and other feedstocks — is expensive, and not nearly enough of it is being produced for airlines to even come close to meeting their sustainability goals. Airlines and aerospace manufacturers have called on government to help incentivize and subsidize SAF production, and certain companies including United Airlines Holdings Inc. have invested directly in clean energy startups. But it’s logical that some of the burden would eventually fall on passengers as well. Other airlines including United and British Airways have offered passengers the option of donating to support SAF, but Air France-KLM appears to be the first to make surcharges automatic.
Canadian National Railway Co., the railroad whose own bid for Kansas City Southern was thwarted by regulators, will ask those same regulators to require the winning buyer, Canadian Pacific Railway Ltd., to divest a chunk of tracks to it. Kansas City Southern’s lines running from Kansas City, Missouri, to Springfield and East St. Louis, Illinois, compete directly with certain Canadian Pacific routes, and the acquiring railroad intends to prioritize its existing tracks, Canadian National said. If Canadian National were to acquire the Springfield line, it would invest at least $250 million in upgrades and use the tracks to better compete with the more emissions-heavy trucking sector. Canadian Pacific wasn’t thrilled by this suggestion, arguing that the proposal is built on “a series of factual errors or misstatements” and that the Springfield line isn’t actually parallel to its own connection between Kansas City and Chicago.
Elsewhere in deal regulation, Reuters reported that the Federal Trade Commission is delaying a vote on Lockheed Martin Corp.’s $4.4 billion purchase of Aerojet Rocketdyne Holdings Inc. by as much as two weeks. The deal was announced in December 2020. Aerojet shares fell this week to around $44, about $7 below the offer price, in a sign some traders are skeptical the transaction will close.
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