For the past few years I’ve co-hosted an interesting dinner, where I ask each guest to speak for less than 2 minutes on a way they think the world will change in the next 5 years – that is not obvious.
In December I hosted 70 leaders in a wide variety of disciplines – from horticulture to economics. The guest list included; 2 Governors, 7 CEO’s of companies of more than $2 billion in revenue, Chief Investment Officers of more than $38 Billion, 11 venture capitalists, etc….so you get the idea.
The 70 ideas were then voted on by each table, and below is a finalist – on ways the world will change that are not obvious. Please share your ideas on other non-obvious predictions and your thoughts about this one.
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My idea has to do with inflation, which many people are expecting, but specifically the effect of inflation on the U.S. supply chain, which will be very disruptive.
The U.S. supply chain is $1.8 trillion annually. For sake of comparison, the U.S. healthcare industry, changes to which have led to much ink being spilled, is $2.4 trillion. So this is massive, 13% of GDP. The trend over the last 20 years has been to embrace “just in time” inventory management. But JIT has an unexpressed premise: namely, deflation. In addition to its effects on cash flow, there’s a collateral benefit to pushing production out to be as close to the point of sale, when the costs of that later production are lower than today’s production because of deflation in labor and materials.
So my question is: what happens to that whole model, premised on deflation, and to the supply chain in general if we experience massive inflation?
The sharp spike in inflation many are predicting will erode that specific benefit of JIT. There are multiple sources of inflation: raw materials costs, fuel expenses, regulatory compliance costs and devaluation of currency through fiscal and monetary missteps. The greater number of these which hit, the worse the picture will be. Raw materials and fuel have been in a 20-year deflationary cycle and always rise significantly in periods of monetary inflation. The costs of operating trucks will go up rapidly even if fuel prices are stable, because of environmental compliance reasons. History shows no periods of rapid increases in money supply which are not followed by increases in inflation.
This will most likely play out in the area of transporting goods. Today, the cost to ship goods in anywhere from 5x-7x the cost to store them. As reluctant as companies are to hold any inventory, they will do so as an inexpensive hedge against a massively higher cost to transport. They will not greatly expand inventory but decentralize it by operating multiple regional and smaller footprint distribution centers in proximity to their major markets.
There are two sentinels of this change: One is Buffett’s purchase of Burlington Northern, which validates the idea of greater use of the rails. The interesting thing about this purchase was that he is known as a deep value investor, yet he paid a 30% premium to market. More interestingly, coal represents 40% of rail freight business, but it seems likely that it is not a fuel of the future. So stepping down coal revenues to Burlington over time only increases the size of Buffett’s premium. The other sentinel is JB Hunt’s initiative to move from being a long haul carrier to extreme short haul, or being the carrier of the final mile, which may mean they see operating costs of trucking spiking.
I predict that the drastic rise in shipping costs will lead to many smaller regional DCs with some uptick in inventory levels, an increase in market share of the rails, a meaningful reduction in the long haul trucking business, and that all of these can happen due to increased operating expenses and inflation even without a rise in the materials costs.
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What will this mean for Open Innovation or Venture Capital? Watch for transportation related technologies. Have a better way to track containers? Have a better way to increase transportation uptime? Have a better routing optimization approach? This could be your time.
Great information! I’ve been looking for something like this for a while now. Thanks!
Who ever wrote this artcile really knew what they were talking about.
Seriously Good blog post. I have got to say that it’s been very fascinating seeing investing recommendations change in the last couple years. What do you think?