Consumer demand came raging back this year. The supply chain wasn't ready for it, and now retailers, brands and consumers are paying the price.
Early in the year, toy maker Basic Fun raised its forecasts by 20%. At the time, COVID-19 vaccines were rolling out, consumers were awaiting fresh stimulus checks and more of the economy was reopening as virus cases fell.
"And then we start to hit April, May and June, and we're like, 'Holy crap, we might have to bring our forecast back down because we can't get containers,'" Jay Foreman, CEO of the toy maker, which sells to some of the largest retailers in the country, said in an interview. "And not only can we not get containers and space on ships, when we do the price of freight is triple. Which is just a hit right to the bottom line."
Last year at this time, retailers were trying to work through the impossible calculus of unpredictable consumer demand headed into a holiday season bound to be shaped by the COVID-19 pandemic. Today, demand is strong, the economy is booming by several measures and store traffic is up from last year, though new variants could slow things down.
Now it is the supply of goods that is scrambling retailers' best-laid plans.
At key points in the supply chain there are raw material shortages, labor shortages, shipping container shortages, freight space shortages and facility closures. Across the board retailers are wrestling with higher freight costs and constrained shipping capacity.
Much of that is a hangover from last year. When retailers curtailed their buying amid store closures and demand drop-offs, carriers in response took some capacity out of play by mothballing container ships. The surge in U.S. consumer demand came before shippers and carriers were ready for it.
Some of the current strains are also due to the pandemic. The Yantian port in China shut down this summer after a COVID-19 outbreak, creating a major global shipping backup. Manufacturers around the world are also playing catchup, and those in countries with lower vaccination rates than the U.S. and other wealthy countries have been affected by the virus as well, including major producers like India and Bangladesh.
And all of this is happening as retailers and brands are gearing up for the hugely important holiday season.
Retailers' choices in that context are limited, ranging from financially painful to excruciating. "You can pay, or you can wait," said Chris Considine, a director in AlixPartners' retail practice, in an interview. "Those are your options."
In other words, retailers must either fork out money for skyrocketing freight rates or face delays shipping goods — and the higher rates don't at all guarantee timely arrival of goods.
The American Apparel & Footwear Association President and CEO Steve Lamar recently described the current situation as an "acute shipping crisis" and "dire situation" driving inflation. In a letter addressed to President Joe Biden, Lamar asked the administration to take action to help end "a destructive cycle of lengthening delays and rocketing costs."
AAFA's Nate Herman, senior vice president of policy for the trade group, called shipping costs and delays "an existential crisis" for the industry. In an interview, Herman told the story of one firm, which the group works with, that has been trying to get product into the country.
The company, a luggage brand, typically has 11 container deliveries shipped in every year by August — in time for the holiday season — at a cost of $2,500 per 40-foot container. Travel this year is ramping back up, and the brand's products are once again in demand. Normally, that would be great news.
But so far the company has only been able to get three of its usual 11 shipments in, according to Herman. A carrier told the company it could get a container into a ship in Thailand for $15,000 — if the company could manage to get the container to the country from Mayanmar. (Trucking has its own shortage issues in Asia as well.)
The firm was able to truck the container from Mayanmar to the Thailand port for another $3,000, making for a total of $18,000 in freight costs on a container that usually cost $2,500 to ship, and which carried products worth $30,000 in value. That means freight amounted to well over half the products' total value, according to Herman.
The 'biggest risk' to profits
B. Riley Securities analyst Susan Anderson said in a June research note that freight prices were the "biggest risk" to the apparel sellers under her team's coverage area.
Anderson estimates that companies were purchasing freight 50% to 100% more compared to last year, and that at current rates freight was hitting margins to the tune of 60 to 125 basis points.
The shipping bottleneck is forcing retailers in multiple sectors to pay steep prices and make major buying and supply chain decisions to ensure the arrival of products for their shelves.
In Burlington Stores' recent June conference call, for example, the word "freight" came up 20 times. CEO Michael O'Sullivan said that freight expense had risen by 110 basis points in the first quarter compared to 2019, and the company is predicting an operating margin decline of up to 80 basis points, driven by higher supply chain costs, according to a Seeking Alpha transcript.
The timing is made more painful as demand ramps back up. "Inventory levels are well below historical values, and demand is surging," said Considine. Most retailers won't be able to fully replenish their inventory levels until 2022, and meanwhile freight costs have increased by two or three times, Considine said.
All of that means that the surge in demand can actually have negative ramifications for retailers and brands. "This is one of those years where, for some companies, business can be so good it's bad," Foreman said.
"If you're a company that normally does $10 million a year, and you think you can do $12 [million] or $13 [million] this year, you've probably bought that extra $3 million worth of goods from your suppliers, and your customer wants the goods," Foreman explained. "But your supplier can't get the goods shipped. And now you're going to be in a situation where you might end up getting cancellations" from customers.
So what can retailers do? That depends in large part on their size and resources.
Companies with deep pockets can, to an extent, buy their way out of the crisis. Home Depot, for example, contracted out its own container ship to ensure it had capacity on an ocean-crossing vessel. "We have a ship that's solely going to be ours and it's just going to go back and forth with 100% dedicated to Home Depot," company COO Ted Decker told CNBC.
Foreman said that the largest retailers, including Walmart, have the leverage to buy up space on container ships, which leaves even less room for smaller players.
Those with the capital to do so can also build out infrastructure to smooth the process.
Considine said one retailer he is working with bought space near ports in Asia to stage containers. Having storage capacity and a staging area for product ensures the company can use any space it has booked on container ships and buy up the best spot rates when they become available.
Others are trying to leapfrog the ocean altogether with air freight. For some, the need to get products to stores justifies the expense.
But as PVH COO and CFO Mike Shaffer noted in a June conference call, air freight is not just more expensive, it also has capacity constraints at the moment. Even so, the apparel seller, which owns the Tommy Hilfiger and Calvin Klein brands, has built in air freight costs and four-to-six week inventory delays as it tries to maintain its sales plan in the second half of the year.
When it comes to air freight and other alternative transport methods, the product matters as well. As one example, Shaffer said that "underwear is particularly one where we can get goods in quicker" without incurring any great extra cost.
Once a retailer or brand gets products into the country, there are ways to offset the extra costs, including passing them on to the customer.
B. Riley's Anderson said that "we believe retailers can more than offset these [costs] with price increases, lower promos, and lower rent." The analyst team pointed to apparel prices, which remain below 2019 levels and, they argued, have "room to raise prices, particularly as demand remains strong and supply lean."
As Considine said, "The end customer, no matter what the retailer's efforts are, is getting impacted here." That could take the form of longer delivery times, higher free-shipping minimums on purchases, passing on direct costs of shipping to customers or higher product prices.
Once the holiday season kicks off, Considine said that many retailers will likely tailor their marketing to the reality of their inventories. Categories and SKUs where the company has product depth will get the most promotion; the hottest deals will have limited inventory; and some product deals, such as on laptops, which are hot commodities come Black Friday week, may sell out in hours, Considine noted.
Getting to the table
The AAFA and others have pointed to policy solutions that could ease the bottleneck and lower prices. Chief among them would be infrastructure improvements, according to the AAFA.
But the AAFA's Herman notes an infrastructure bill, if it could make it to Biden's desk at all, probably wouldn't emerge from Congress until well after the holiday season is over. And then it would be years for the improvements to be built and come online.
In the group's letter to Biden, Lamar called for further rulemaking and aggressive enforcement of existing rules and regulations from the Federal Maritime Commission to reign in "the scourge of unfair and excessive detention and demurrage fees" as well as breaches of contract.
The FMC recently launched an auditing program to examine the billing practices of ocean carriers, though it is unclear what action may result from it.
With rulemaking and legislation taking time, Herman said the group sees "one thing, one single thing that will make the difference." That would be Biden using the bully pulpit of the presidency to bring all stakeholders to the table to negotiate a solution to the current crisis.
A meeting doesn't guarantee a deal will come out of it, though. For one thing, an existential crisis for shippers has been a profitable, if chaotic, period for many ocean carriers, which have over time consolidated into nine firms controlling roughly 85% of the global market.
In May, Maersk, the world's largest container shipping company, reported record profits and a 30% increase in revenue for its first quarter.
"The high growth and profitability were driven by solid demand across Ocean, Logistics and Terminals, coupled with strong freight rates," said Maersk CEO Søren Skou in a letter to investors. "Strong demand combined with bottlenecks, lack of capacity and equipment shortage in the global supply chains drove freight rates up significantly."
With or without a compromise of some sort, the bottlenecks are likely to continue for the foreseeable future. Considine doesn't expect to return to some kind of normal until next year.
"The supply chain executives that I work with are planning their capacity to be available and the inventory build to be stabilized into 2022," Considine said. "Where in 2022 is an interesting question."
As for freight costs, get used to them. They may level out at some point, but not at where they once were. "We'll obviously see [rates] well and truly higher than what we saw in 2019," Considine said.