The headlines for the last few months in the United States relating to the coronavirus pandemic mostly address issues like testing and infection rates, so it can be easy to forget that the first effects of the pandemic felt in North America related directly to the shutdown of the Chinese economy. We addressed some of these concerns early on, but put off the discussion of possibly the most important aspect of the early crisis: supply chains. While we did talk a bit about this topic briefly in our previous post, it’s important enough to warrant an entire discussion on its own.
Modern supply chains tend to be increasingly efficient; the development of data science and the ever-increasing amount of data available has made it possible for companies to streamline their production systems in a way that would not have been possible even a few decades ago. As a result of this approach, many companies carry little inventory, and rely on suppliers located in other countries. Under normal circumstances, data from previous disruptions can help to anticipate and mitigate problems, which is why this approach has been surprisingly resilient in the past. However, the current pandemic is unprecedented; without the data and experience to anticipate this kind of disruption and the lack of inventory to weather it, the shutdown of the Chinese economy caused supply chains all over the rest of the world to collapse.
On the surface, it seems that the best way to deal with this problem is to adopt what is known as the “China+1” strategy. With this approach, companies diversify their supply chains to include both China and one other country where the cost of manufacturing is relatively low – for example, Mexico, the obvious choice for American companies given proximity, extant business connections, and the USMCA.
However, this approach is still not sufficiently resilient to pandemic risk – after all, many supply chains within the United States were disrupted once lockdowns began domestically. Furthermore, it exposes the supply chains to additional risk in the second country, while still making the part of the supply chain in the second country at least partly dependent on operations in China. This last point is worth considering – for companies based in the United States, any reliance on China could be problematic down the road, given the increasing tensions between the two countries.
More heavily diversified approaches face more fundamental difficulties; improving supply chain resiliency necessarily means losing some efficiency, which translates into higher costs and more difficulty in competing with companies that do not work to mitigate this risk. In addition, some changes will simply not be practical or desirable. For example, many Japanese businesses would like to diversify their supply chains, but even with the government offering generous subsidies, leaving China does not seem to be economically feasible. More importantly, the reason China has become such an important industrially hub is because it made it easy for companies to work there efficiently, and has followed through in that regard by adeptly managing the reopening of industry after the lockdown.
Increasingly, it seems that the most important approach to dealing with supply chain disruption is to identify critical weak points in the supply chain as a whole; businesses can then either make small but highly productive changes or put a system in place to anticipate disruptions at those critical points. In some sense, this means taking the analytical tools that have been developed to create efficient supply chains, and using them in order to develop more resilient ones.
This approach takes the form of supply chain mapping. In this process, companies construct a detailed model that demonstrates where their inputs come from, ideally all the way down to the level of raw materials. In building and maintaining this kind of model, it becomes easier to determine how a disruption in a given country or a given industry, even one that is not directly connected to the company, might affect production, weeks or even months in advance.
Whether or not this approach to supply chains becomes common will depend at least in part on actions by governments, investors, or insurance companies. Of course, if supply chain mapping requirements are put in place, it will constitute a significant initial investment, as well as an additional maintenance cost, for many companies. This might not be in the interest of any given business, at least in the short term, but increased regulation in this regard, at least for critical supply chains, is very much on the table.
Aside from being able to stress-test their supply chains, this kind of mapping also gives companies access to a relatively new financing option: payables finance. With this approach, large buyers provide liquidity when more traditional mechanisms are unavailable by providing early payments on orders. Combined with supply chain mapping, this option becomes a very powerful way of maintaining supply chains during times of crisis, because it allows large companies with readily available capital to sustain entire segments of their supply chain that are temporarily under pressure. In this sense, suppliers can stay afloat, while buyers can quickly restart operations once the crisis ends.
Alternatively, smaller companies that map out their supply chains will be able to better anticipate temporary shortages and come up with stopgaps. This could take the form of holding additional inventory of certain raw materials, or preparing a mechanism, even one that is relatively inefficient, that could be used temporarily to continue production and maintain contracts. 3D printing, where applicable, is a good example of one of these mechanisms.
The pandemic has shown us that companies will clearly benefit from paying more attention to where they get their raw materials from. While it’s very unlikely that this crisis will mark the end of globalization, big changes are no doubt coming. Whether your motivation is to prepare for upcoming pandemic-related disruption, to get out ahead of other companies, or to be in a better position to deal with new government regulations, paying more attention to supply chain risk management is certainly a good idea going forward.