Dec. 2, 2021

Something’s Got to Give: Firms See Continued Supply Disruption and Labor Constraints Decreasing Revenues and Adding to Costs

Brent Meyer, Roisin McCord, Sonya Ravindranath Waddell

The supply constraints facing the U.S. economy are manifesting themselves in everything from slower growth to rising costs. Moreover, the U.S. economy has struggled to return to pre-pandemic employment levels in February 2020. In the second quarter of this year, firms in The CFO Survey told us that labor shortages were constraining production and reducing revenue. Third and fourth quarter results point to widening constraints on labor supply and intensifying supply chain disruptions that are showing up as rising costs that could feed through to higher prices. Together, these obstacles to production appear to be taking a bite out of growth that is likely to last well into next year.

The Disruption of Supply Chains

In the third quarter wave of The CFO Survey, we posed a series of questions on supply chain disruptions to better understand their extent, their impact on 2021 sales revenue, how long firms expect them to last, and what (if anything) firms are doing to mitigate their impact.

Roughly seven out of 10 firms across all sectors of the economy were experiencing supply chain disruptions. (See the chart below.) These figures are broadly consistent with other survey results (such as the Atlanta Fed’s Business Inflation Expectations Survey, the NFIB’s Small Business Economic Trends, and the Richmond Fed’s Business Surveys).

In addition to being widespread, these disruptions have negatively affected firms’ ability to meet strong customer demand. Firms reported that these disruptions have decreased the availability of materials, delayed production and shipping, and increased costs. To gauge the size of the impact, we first asked firms whether supply disruptions have resulted in lost or delayed sales. Of the firms reporting supply chain disruptions, more than 75 percent reported lost or delayed sales. This suggests that over half of all responding firms have experienced disruptions that have caused the firm to lose or delay sales. Perhaps unsurprisingly, the impact of supply chain disruptions is not consistent across industries. Compared to many services firms, disruptions are much more frequent among retailers, wholesalers, and manufacturing firms.

The revenue loss could be significant: Fifty-five percent of firms reported lost and/or delayed sales due to supply chain disruptions, amounting to about 5 percent of 2021 sales revenue, on average, among that group. Smaller firms reported a larger average reduction (7 percent) than larger firms (4 percent). In aggregate (including those with no revenue-impacting disruption), these results indicate a 2.9 percent reduction in U.S. firms’ 2021 nominal sales. This reduction varies by industry, with the largest impacts in manufacturing and retail, but altogether the impact is larger than the impact of labor shortages in July.

Of course, firms are taking action. Many firms reported diversifying supply chains, switching to suppliers closer to the United States, attempting to increase inventories, and changing shipping logistics (e.g., moving products via airfreight instead of cargo ship). Interestingly, smaller firms (fewer than 500 employees) disproportionately reported being ill positioned to maneuver supply chain disruptions and more frequently indicated a wait-and-see approach.

Supply Disruptions Come at a Cost

In the fourth quarter, we asked a series of questions on cost changes. Almost 90 percent of respondents reported experiencing abnormally large cost increases in at least some of their inputs. These larger-than-normal cost increases were most pronounced in manufacturing and construction, but even in business services, the overwhelming majority of firms are reporting salient cost pressures. Moreover, these cost pressures have spread quickly compared to when we asked this question two quarters ago. Back then, roughly a quarter of respondents reported larger-than-normal increases in the majority of their costs. In just six months, that share rose to four out of 10.

Although the larger-than-normal cost increases should abate over time as bottlenecks free up and production increases to meet surging demand, firms’ adjustments in response to the current situation might have a longer-term implication. It seems likely that firms chose their pre-pandemic supply chain configuration for efficiency and now express a desire to make their supply chains more robust to disruptions. These adjustments are likely to come with higher production costs. Two clear examples of these higher cost adjustments are holding more inventory and changing shipping logistics (i.e., from container ships to airfreight). These adjustments will likely increase the cost of production over a longer period of time, on top of already costly actions like switching suppliers or discontinuing products and services.

Firms would not undertake these transformations if they expected a quick resolution to these disruptions.  As the chart below indicates, more than 50 percent of firms anticipate production and shipping delays, materials availability, and cost increases to remain until the second half of 2022 or later. As Atlanta Fed President Raphael Bostic noted in a recent speech, “It is becoming increasingly clear that the feature of this episode that has animated price pressures—mainly the intense and widespread supply chain disruptions—will not be brief.”

The fourth quarter results on firms’ expectations for the longevity of the cost increases corroborate this time frame. More than 60 percent of respondents expect the larger-than-normal cost increases to last into, if not past, the fourth quarter of 2022.

To recap: Constraints on firms’ ability to meet demand stemming from supply chain disruptions are widespread and are leading to moderately lower revenue growth (and thus lower output overall in the aggregate economy). Large firms especially are engaging in myriad adjustments to deal with supply disruptions. In addition, these shifts in supply chains, alongside the length of time firms anticipate resolution suggest a sea change. The move from a potentially fragile, but efficient, supply chain to a more robust, costly one (“just in time” to “just in case”) is evidence of structural change, which could result in permanently higher production costs and potentially feed into higher price growth.

Part II: Labor, When You Can Find It, Is Getting More Expensive

As if the widespread and significant supply chain disruptions weren’t enough, they are part of a dual threat to firms’ ability to meet demand. Reports of labor shortages are widespread, with three-fourths of respondents indicating difficulty finding new employees. And, these difficulties do not appear concentrated in any particular sector of the economy. (See chart below.) As we reported in July, these labor constraints are depressing sales revenue.

Prior to the pandemic, firms reported having trouble filling open positions, but nominal wage growth remained low, which was hard for economists and policymakers to square. Currently, with national job postings at an all-time high — an indication of even more widespread difficulty hiring workers — we are also gathering evidence of stronger wage growth.

More than 80 percent of The CFO Survey respondents that reported difficulty finding workers also indicated increasing starting wages/salary offers for new hires. In addition, one-third are implementing or exploring automation to replace labor — something we reported in an earlier quarter.

The firms that were raising wages reported average increases of roughly 10 percent. Wages are going up for new low-skill workers slightly more than for high-skill workers, on average, but even high-skill wage increases for new hires (9 percent) are notable. Of course, these are new hire increases, but wage compression could lead firms to readjust existing employee wages to preserve wage structure. Most firms report that the new hire wage increases will impact their entire wage bill in future months and years. This is consistent with national data: Average hourly earnings for all employees have increased, and in the third quarter, the employment cost index recorded its highest year-over-year increase (4.2 percent) in decades. Further, data from the Atlanta Fed’s wage growth tracker supports the notion that wages of job switchers are outpacing the continually employed, and low-skill wage growth is outpacing wage growth for high-skill occupations over the past year.

What does all of this mean? Pandemic-induced constraints on production are legion. Supply chain disruptions and labor shortages are leading to forgone and delayed sales as well as growing cost pressures. One unique aspect of these supply shocks is that firms do not appear to have a release valve for building cost pressures. Typically, firms can offset, for example, rising oil prices by keeping a lid on wage growth. After squeezing profit margins, the only place these pressures can go is into higher selling prices. Combined with slower output growth due to both supply and labor constraints, something’s got to give.