Walter Kemmsies, managing director, economist and chief strategist for JLL Ports, Airports and Global Infrastructure, discussed how interest rates are on the rise and the effects this could have on the supply chain.
Interest rates have risen significantly in the last few months, and comments from the Federal Reserve about the state of the economy indicate that rate hikes are likely to continue. Inventory ties up financial capital because, with some exceptions, producers must pay suppliers before the goods are sold and revenues are received. If interest rates continue to rise in 2017, it is likely that there will be pressure to reduce the amount of inventory held in order to support sales.
From 1992 to 2010, the inventory-to-sales ratio for multi-product retail stores declined dramatically due to increased efficiency in supply chains. These efficiencies were achieved despite the increasing complexity of supply chains, as retailers increasingly sourced their merchandise from foreign suppliers. Since 2010, however, inventory-to-supply ratio trends have reversed.
It is generally believed that e-commerce companies are keeping more goods in more locations because online customers demand more choices and shorter delivery times, which has translated to one-day or even same-day delivery. E-commerce retailers who are unable to meet these demands run the risk of losing customers to their competitors.
In order to protect their market share and/or increase sales, e-commerce retailers need to expand the geography that they serve. Unlike traditional brick-and-mortar retailers who can hold inventory in a centralized warehouse that supplies many stores over a wide region, e-commerce retailers need to hold inventory closer to potential delivery locations. Thus, it stands to reason that increases in e-commerce’s share of retail sales (see New clash of the titans, American Shipper, September 2016, pg. 30) is the reason that inventory-to-sales ratios stopped declining in the last five years.
There are factors other than the shift from the brick-and-mortar model to consider as well. The Great Recession, which according to the National Bureau of Economic Research began in December 2007 and ended in July 2009, had its origin in a financial crisis that provoked the Federal Reserve to not only set short term interest rates at 0 percent, but also to buy government bonds in large quantities – referred to as “quantitative easing” – so as to push their prices up and the yields down to historic lows. Even though the Fed has abandoned the bond buying policy and increased short-term interest rates, they remain close to those historically low levels.
Low interest rates mean that the financial cost of holding inventory is low. And given that commercial and industrial real estate vacancy rates were high, the operational cost of holding inventories was also relatively low. Even if e-commerce was not gaining a share of retail sales, given low interest rates and real estate lease costs, one would expect the inventory-to-sales ratios to stop declining and perhaps even rise as seems to have been the case in the last five years. This may also explain, in part, why seasonal peaks in imported container volumes have been relatively muted during this time period.
Industrial real estate vacancy rates have fallen again in 2016, according to JLL research, indicating that real estate costs are likely to rise. With the unemployment rate below 5 percent, a level that economists consider to be a non-accelerating inflation rate of unemployment, it is likely that the Federal Reserve will raise interest rates to head off an increase in inflation.
If the costs of holding inventory increase, beneficial cargo owners will be under pressure to reduce the amount they hold, but also to avoid stock-outs since this can result not only in lost sales, but in loss of market share as well. Those pressures are likely to be felt across the entire freight movement service industry, and falling inventory-to-sales ratios will be a primary indication that this is indeed happening.
Kemmsies is managing director, economist and chief strategist for JLL Ports, Airports and Global Infrastructure. He can be reached by email at walter.kemmsies@am.jll.com.