The Covid-19 outbreak has thrown businesses and investors into a frenzy thinking about the long term viability of their business models. Inherent in all the crystal-ball-ing that everyone is trying to do is to address the question of what life post-Covid will be like. Without knowing that answer, businesses have to make reasonable guesses and try to balance the interests of multiple stakeholders.
As the 1Q20 earnings season in Singapore comes to a close, I noticed that most analysts have identified the duration and severity of the Covid-19 virus as a key catalyst for share prices. While I believe that this is true, I think it is also important to focus on how managements are balancing various priorities and how this sets them up to take advantage of the catalyst aforementioned. My article will attempt to identify some of these balancing acts that companies have to do and give examples of companies that have gone both ways.
Covid19 has caused the closure of borders and the disruption of supply chains globally. Where goods used to freely move across borders, we are now seeing countries restricting outflow of goods for their own national stockpile. Similarly, companies face supply disruptions.
Taking the example of a supermarket chain, when there was panic buying they were faced with a short supply of goods to sell to consumers. Typically, supermarkets would have estimated consumer demand and kept a small amount of stock in warehouses; this was to reduce the cost of storage and ensure that consumers always receive the freshest goods. However, due to the demand spike, supermarkets have had to grapple with the following decision
1. Built-in redundancies
2. Diversity of supplies
3. Localization/control of supplies
1. Built-in redundancies
By keeping additional stock in the warehouse, supermarkets would have the spare capacity to meet demand spikes. While it is possible to let this 'demand' go unsatisfied, it could be detrimental in the long run if consumers decide to go to a competitor and stick with that competitor. Psychologically, there could be the thought that the competitor is better as he was able to meet the consumer's needs during times of crisis and hence invoke a greater sense of customer loyalty.
On the flip side, having additional stock or some built-in redundancies like extra manpower to stock goods or be cashiers can lead to additional costs that businesses have to bear. For a supermarket that also sells perishables, the freshness of produce is an important factor. The larger amount of stock that supermarkets hold may also be at risk of expiry/spoilage if demand tapers off more than expected. As of 1Q20, Sheng Siong Group reported a quarterly net profit margin of 8.8%. Increases in warehousing and logistics costs as a result of the redundancies would eat into already-thin margins.
2. Diversity of supplies
During multiple interviews/briefings, Singapore's Minister for Trade and Industry highlighted that Singapore has a diversified set of food suppliers and that would help reduce the risk of shelves going empty. Similarly, supermarkets would do well to ensure they have goods sourced from multiple suppliers instead of just one for risk management purposes. In the event there is a disruption from one supplier, at least the other supplier can pick up some slack. There is also the added benefit of having a greater selection of goods for consumers.
However, businesses have to balance how diversified they want their suppliers to be as this can often drive up costs and take up a significant amount of manpower to manage multiple relationships. Supermarkets may find that ordering 100% of their apples from 1 supplier may allow them to achieve a lower cost price due to bulk discounts.
3. Localization or control of supplies
Another point that is frequently highlighted is the need for localization of supplies. In Singapore, >90% of our food supplies are foreign-sourced, making us more vulnerable to trade shutdowns. Therefore the Singapore Food Agency has come up with a goal to have 30% of our food produced locally by 2030. Similarly for supermarkets, they may wish to have greater control over the value chain by diversifying upwards into having more house brands or their own supply chains.
Apart from cost considerations, the shift into another business model (albeit complementary) may dilute the management time and focus on its core business.
Due to the uncertain nature of the Covid-19 virus and varying nature of different business models, companies have to weigh the cost and benefits of tilting the balance for their operations. Importantly, company managements need to have a thorough understanding of their own strengths and weakness as well as the opportunities and threats of their industry.
