Big companies like Apple Inc. (NASDAQ:AAPL) have been shifting Chinese supply chains to other locations in Asia including India and Vietnam due to geopolitical risks. Japanese conglomerates are doing the same while, more recently, multinationals have been onshoring activities to the U.S or nearby countries like Mexico due to China applying tough Covid-19 lockdown measures.
However, unless you are a big producer boasting millions of units, exiting China is not easy and costs money too, and subtracting the lockdowns, the Asian country still offers a resilient supply chain for small and medium-sized manufacturers that depend on outsourcing to be profitable.
Therefore, it is also about how supplies management and using their usual cloud-as-a-service approach. Hyperscalers Google (NASDAQ:NASDAQ:GOOG, GOOGL) and Amazon (NASDAQ:NASDAQ:AMZN) propose solutions with their Supply Chain Digital Twins. The aim of this thesis is to compare them with the aim of assessing how these can impact the EV-to-EBITDA multiples of the two companies, which are down by at least 30% since the last year.
For this purpose, the global SCM (Supply Chain Management) software market is expected to grow at a CAGR of 18.1% from $30.79 billion in 2022 to $59.93 billion in 2026. This is a huge amount and I start with Google which first released its supply chain twin solution in October 2021.
First, Covid-19 has caused disruption in many organizations’ manufacturing systems, supply chains, and distribution networks. At the same time, the pandemic has brought a fundamental shift in the way corporations use technology. This means that organizations are looking to digitally transform their supply chains, but, classical software methods involving simulating what could happen to the sourcing of a product when subjected to various conditions and is somewhat limited.
In sharp contrast, Google’s Digital Twins work by building a digital replica of the physical supply chain through different data sources, with real-time feedback obtained through technologies such as sensors and the Internet of Things ((IoT)). Advances like virtual reality can even enable user interactions. Going a step further and packaging the offer through its Google Cloud Platform (“GCP”), the internet search giant provides the new service on top of its Supply Charge Pulse module, which provides dashboards, analytics alerts, and collaboration within Google Workspace.
Digital Twin (cloud.google.com)
Looking at the strategy, it is more about helping existing retail customers from Google’s ads business as they look for digital transformation. One example is a luxury brand plays LVMH Moët Hennessy (OTC:OTCPK:LVMUY) looking to change its interaction with its customers. Other use cases involved helping organizations manage surges in traffic data following peaks in customer queries as well as address supply chain disruptions through the use of virtual assistants.
As per one GCP partner report, there have been instances where inventory-related expenses were slashed by 50% using the visibility provided by the digital twin. Delving into car manufacturing Renault (OTC:OTCPK:RNLSY), is leveraging the technology to aggregate and organize inventory data from suppliers in order to orchestrate operations.
While everyone is focused on Google, Amazon is silently progressing with its AWS IoT Twin Maker as evidenced by this job posting which stresses “Supply Chain Management” in addition to Enterprise Resource Planning (“ERP”) and Customer Relationship Management (“CRM”).
In the same way, as Google, Amazon’s strategy is to build digital twins out of physical processes so that customers can use real-world data derived from IoT measurements, but, the intent is more to efficiently monitor operations at industrial sites. Its twin maker also integrates with business applications and brings the same ease-of-use and pay-as-you-go functionalities available in AWS into its retailing business.
AWS IoT Twin Maker (aws.amazon.com)
Now, one of Amazon’s advantages is that in contrast to Google, it already has an online retailing business with a huge marketplace comprised not only of millions of buyers and sellers but also fulfillment centers that makes sure that items are delivered to the end customer.
Another advantage is that it has deep experience in logistics given the fact that the company spends over $150 billion on shipping and fulfillment charges in 2021, up by 32% from 2020. Consequently, it has been investing billions of dollars to get more control over its supply chain since 2014 and it now has a vertically integrated logistics network that rivals some of the world’s largest delivery companies like United Parcel Service (UPS).
Looking at use cases, customers including Invista have conceived a digital twin of the manufacturing function using operations data in order to provide field workers with a consolidated view of all assets. Others, like Carrier (CARR) and John Holland (in Australia), have used data analytics and machine learning tools to reduce service costs and optimize maintenance schedules respectively.
Consequently, Amazon is leveraging on its experience in the warehousing and logistics businesses and stands to benefit the most when solving supply-related issues through its AWS cloud infrastructure. The next step is to identify the value generated.
First, whether it is the use of digital twins to achieve a control tower type view, building cloud-based data warehousing, or gaining control of logistics, the concept revolves around using AI tools to process data in a differentiated fashion in order to obtain actionable insights. Furthermore, with their enthralling cloud interfaces, application-as-a-service service delivery, and an end-to-end approach to the supply chain issue, hyperscalers also touch upon the client domain as seen with the way Google enhanced customer experiences.
These are the reasons why in addition to the supply chain realm, I also include cloud AI and CRM in an estimate for the potential market size, which totals $218.82 billion as per the table below.
Table built using data from (www.seekingalpha.com)
Based on AWS’s 33% cloud market share at the start of 2022, it could rake in $72.12 billion (218.82 x 0.33) by 2029 which is more than the $62.2 billion Amazon’s cloud unit generated in 2021. As for Google, with a 10% market share, it should garner around $21.88 billion.
Next, considering the amount already generated by these two companies in 2021 as per the table below, revenues from supply chain twins will not only positively impact the top line, but also the bottom line as well, as I explain below.
Comparison with peers (www.seekingalpha.com)
Based on an EBITDA margin of 35.45%, Google should generate $730 million (21.88 x 0.3545) through digital twins by 2029, while Amazon will make $840 million (72.21 x 0.1166) based on margins of 11.66%
These millions do not make for a significant difference in the forward EV/EBITDA metric of 11.39x and 16.39x for Alphabet and Amazon respectively, and this is the reason I have a hold position on both stocks currently. Still, given SCM tools are now gaining traction rapidly, the two companies could see related sales faster.
Moreover, digital twins constitute a cushion against some uncertainty as to their cloud businesses. In this respect, these hyperscalers do face headwinds like corporations shifting to hybrid and multifold strategies which signify that fewer IT workloads will be moved to their infrastructures, in contrast to an all-cloud migration. Additionally, tough competition has resulted in a price war including Microsoft’s (MSFT) Azure, only to be exacerbated by rising energy costs which increase the operational expenses of running massive data centers.
The solution is to build vertically integrated supply-oriented processes on top of their clouds in order to help clients to achieve a holistic view of their inventories and optimize fulfillment. Additionally, digital twins can also be used for demand forecast and budgeting purposes while costing less than traditional ways of doing things. To obtain an idea of cost savings, consider that a cloud or digital server can cost six times less than a physical server.
However, there are other contenders in the SCM software arena.
First, there are already companies offering related applications like LLamasoft which was acquired by Coupa Software (COUP) two years back. Second, Multi-Enterprise Supply Chain Business Networks plays like E2Open (ETWO) and OpenText (OTEX) have solutions that support collaboration across multiple enterprises. Third, SAP SE (SAP) and Oracle (ORCL) through their respective ERP tools have some degree of visibility on a company’s procurement function. Therefore, one risk associated with the digital twin concept is that primarily known for the clouds, it will take time for CEOs to start adopting solutions from Google or Amazon. Also, not all companies have applications lying in the cloud and thus, adoption may take time.
Still, thinking strategically, whether it is Coupa, E2Open, or OpenText, they do not have that scale to be global players, unless they get acquired. As for the two ERP providers, their products are not purposely built to tackle the supply chain problem, and efforts to integrate with the inventories of partners or customers on a real-time basis can prove difficult.
On the other hand, both Google and AWS have massive scales, and the fact that their cloud infrastructures already connect businesses makes it easier for them to integrate with partners across the world through their supply chain twins.
Finally, digital twins may not constitute an impact on valuations at this stage, but, when vertically integrated with the cloud and offering advanced AI capabilities, real-time dashboards, and alert-driven event management, they have the potential to disrupt the SCM ecosystem in the same way as hyperscalers disrupted the worlds of telecoms and IT.
More importantly, they can potentially offset a shortfall of revenues and profit margins for Google and Amazon in a high inflation environment where recession risks have also started to surface.
This article was written by
Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: This is an investment thesis and is intended for informational purposes. Investors are kindly requested to do additional research before investing. This article was edited with the help of Bhoshan Woodun.
I would also like to thank Sean Mathieson, Business Technology Executive for having stimulated me to research the supply chain twins and provided me with some material that I have referred to in this article.