Business Capital Spending Outlook: Supply issues may limit how much a business can acquire

April 15, 2022  |  By Brian Gleason  |  6 Minute Read

With COVID entering the so called ‘new normal’, many businesses are looking to accelerate growth in 2022 and beyond. Expansion capital is plentiful, and still relatively cheap. However, these plans are running headlong into the combination of inflation, supply chain issues, and the lack of availability of resources – both human and capital assets.

Companies looking to add capacity through new production lines or new factories, or looking to automate processes to address labor issues, are finding that that the assets they need to implement these plans are hard to find today. And, when they do come by these assets, they are more expensive than anticipated.

Supply chain issues are limiting the deployment of CapEx dollars and when they find necessary equipment the time delay from order to getting the assets deployed has stretched considerably. Inflation has pushed the price of capital assets up dramatically even with plans that were made recently. Return on Investment and payback plans may need to be revisited.

Raw material shortages, congested ports, a scarcity of workers, and other factors have contributed to major disruptions in the global supply chain. Many companies have the financing capacity to pay for expansion; however, the ongoing supply issues will continue to negatively impact the availability and timing of purchases and create ongoing complications for businesses. Many budgets will be impacted either because costs went up on CapEx spending, revenue is negatively impacted due to lack of capacity resulting from delayed expansion, or both. Making matters worse, some suppliers are demanding deposits much earlier in the process than in prior years- eating up liquidity for longer. And worse, some are not guaranteeing pricing or have built in price changes due to underlying cost increases.

While there are several risks associated with the capital spending forecast, global supply chain issues, labor issues, and businesses technology investments seem to be the key pain points. Economic growth, with additional impacts from high labor costs and low interest rates are pushing companies to expand their purchase plans to achieve automation; however, the ability to implement these plans timely will be impacted.

Now, let’s discuss how supply chain issues may limit capital spending for businesses and cover some steps your company can take to navigate any obstacles.

Supply Chain Issues Will Continue

Companies will likely face challenges when it comes to capital planning for 2022. In the current environment of high demand and limited supply, inflationary pressure is driving up the cost of raw materials and labor, raising the risk of cost overruns. Over the past decade general inflation has impacted the costs of capital assets by approximately 2%. We are currently experiencing average price increase of 7% and in many industries double digit price increases will be the norm.

The semiconductor shortage continues to play a big part in economic uncertainty, and the demand for goods that use computer chips will remain high. Because of pent up demand and the long lead time to build new factories, supply will not catch up with demand until 2023 or later. While demand for chips rose 17% from 2019 to 2021, supply remains stagnant. It’s estimated that the world’s major chipmakers, largely focused in Taiwan, South Korea and Mainland China, are operating at 90% production capacity; considering required down time this is close to effective capacity. Last quarter, the US Department of Commerce published a survey of major chip suppliers and consumers. The report noted that the median inventory of semiconductor products fell from 40 days in 2019 to less than 5 days in 2021.

Semiconductor shortages will further limit the sales of electronics, motor vehicles, and communications equipment. The already difficult supply chain problems in the semiconductor industry have been exacerbated by the war in the Ukraine. Nearly 50% of the world’s supply of neon gas comes from Ukraine and is a byproduct of Russian steel mills. Neon gas is a critical in the production of semiconductors. Expect further delays, and larger increases from this sector impacting all sorts of other downstream industries.

Additionally, port slowdowns are likely to persist further delaying the time between when customers order goods and when they are shipped. When capital goods are finished and ready to ship, the transportation system has been having trouble delivering them with ships anchored outside of international ports, and domestically with trucks lacking drivers. While the port and other transportation delays are leveling off, they should continue to weigh on the supply chain through the full year.

Labor Shortages Are Still Creating Challenges

Long lead times for equipment will eventually restrain spending, especially with the production of equipment lagging due to the supply chain issues and labor shortages. All indicators are that labor supply will continue to fall short of demand; this will continue to put pressure on capital equipment manufacturers and likely cause an increase in delays rather than a catch up in the near term. Companies facing labor scarcity will have to take proactive steps to prepare for the continued lack of workers, further exacerbating inflation issues, including:

  • Significantly increasing wages and benefits for new employees.
  • Increasing overtime to get more hours from current employee base.
  • Increasing wages and benefits to reduce turnover.  

Actions Companies Should Take

Labor is tight across the economy, and manufacturers face other obstacles on top of recruiting challenges and worker retention. There are several strategies business owners should take to minimize the negative impacts of these issues.

Innovative companies are rethinking conventional supply chain practices to combat disruptions and limit risk. Consider exploring onshoring supply chain and regionalization by moving elements of a supply chain closer to your facility to help reduce transit time and costs or acquire additional warehouse space or sourcing strategies to assist with expansion.

Evaluate suppliers in low-cost countries other than China, where shipping bottlenecks may be less of a problem.

Make sure to assess and monitor the risk of each supply line by looking at factors such as the risk of disruptions, ability to scale, and flexibility of suppliers. Explore potential opportunities to form strategic partnerships with suppliers or a formal cooperative to increase your buying power.

Additionally, companies should invest in technology to improve supply chain resilience by automating to make it easier to plan ahead and spot potential problems. By anticipating a potential shortage or disruption, you can be proactive and take the appropriate steps to minimize the negative impact.

Ultimately, every company has been challenged to re-assess their current business practices, supply chain, and level of risk as they strive to strengthen their organization and expand.

Consider M&A to Help Growth

Businesses across all sectors have been focusing on the growth of their operations over the past several years, in part, to recover from losses due to the COVID-19 pandemic. North American mergers and acquisitions (M&A) were forecasted to fall to 1.06 trillion U.S. dollars in 2020, but are expected to bounce back to 1.36 trillion U.S. dollars in 2022. This year will bring many opportunities and increasing challenges from inflation to the competition for high-quality assets. M&A will be limited by several factors, including high valuations, deal complexity, and a lack of attractive targets left to buy.

However, businesses will continue using M&A to accelerate the execution of their strategic priorities amid ongoing struggles with the supply chain and labor forces. Organizations will be looking to acquire entire companies to help diversify their portfolios and grow. In fact, in some industries, companies are looking to buy competitors just to gain access to employees and capacity.

While businesses have been aggressive in using M&A to implement their strategies, economic variables for some investors will persist due to the possibility of a rise in the cost of capital and potential tax increases. These expectations of rate increases may prompt acquirers that rely on debt financing to move sooner to make deals, rather than later.

Make sure to outline the constraints upon initial evaluation of opportunities, including required diligence, resource availability, and funding sources. This will position acquirers to chase opportunities within their capabilities. The key is to make strategic deals and growth plans. Organizations should expect to see an increasing number of companies building in this area throughout 2022.

Utilize Partners to Assist in Capital Planning

While equipment and software investments are forecasted to grow 4.6% in 2022, supply chain constraints, high inflation, and tighter monetary policy are key obstacles to growth. Companies must prepare for longer lead times and assess how this will impact their capital plans. The delays and price hikes will dissuade some companies from buying more equipment, but as soon as these problems ease a bit, normal purchasing patterns will return.

Some manufacturers will continue to purchase equipment as supply chain issues work themselves out, so that they will be ready to ramp up production when they can. The U.S. manufacturing sector should continue to expand at a healthy rate in 2022, although supply chain issues, hiring difficulties, and high inflation could dampen industrial sector output.

Many of the identified pressure points, and many others, put pressure on working capital and require strong visibility to liquidity requirement. The management of working capital has never been more critical to business success. Partnering with a strong financial advisor who can provide valuable guidance and creative solutions to your financial needs is vital.

Phoenix Management is uniquely able to assess the operations of companies, determine how to position them for success, and assist in the development of financial plans that lead to a path of stable growth.

Contact Phoenix to learn more about capital spending amid the current supply chain issues.

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