From toilet paper shortages to computer chips, the novel coronavirus pandemic has exposed many weak links in the highly globalized supply chains that enable goods to move around the world.
Now, many companies are taking a long, hard look at their models to see if the status quo still works. If the coronavirus broke the supply chain, how do you fix it? What should be changed, and what should not be changed?
There are three parts of the supply chain that have been thrown into question: offshoring, just-in-time inventory, and diversification — and every company reliant on manufacturing is likely examining these factors.
What the coronavirus won’t change: offshoring
From clothing to electronics and much more, things in the United States usually come from really far away, often from China, where the new coronavirus originated. For many companies, this is often unavoidable, because many goods would be prohibitively expensive if made in regions where labor costs are high. Offshoring and outsourcing exploded after 1979, when China adopted its Open Door Policy, allowing foreign companies to access its vast and inexpensive labor market, enabling far cheaper goods than before.
“Anything that was labor intensive — footwear, apparel, assembly of electronics — moved to China,” said Marshall Fisher, a professor of operations, information, and decisions at Wharton. “In 1960, 5% of the world’s physical products crossed boundaries. That’s grown to about 50%.”
The trade-off from offshoring is lead time. A widget produced in China takes a long time to sail to the West, unless you put it on a plane, which eats up much of the cost savings. For many companies, that means nailing predictions to make sure they don’t make too much product or too little, which isn’t easy.
The key aspect with international trade, during the pandemic, is politics. It can be good and bad for business.
Rob Siegel, a Stanford professor who studies supply chains and has created them for businesses, recalled as a business school student in the fall 1993 when former Intel (INTC) CEO Andy Grove told his class that there will never be war with China because “you will never invade the country that has the factories that make all your things.”
Unfortunately, when it comes to pandemics, politics don’t help. Taiwan, a manufacturing powerhouse, banned mask exports in late January as the coronavirus surged. (Taiwan later lifted the ban and donated many masks to other countries.) Dozens of countries — including much of Europe, the U.S., and Brazil — followed, either banning or restricting exports due to coronavirus.
This, perhaps greater than anything else, has prompted the question: Do you really want to rely on X country during an emergency?
However, this is more of a question for governments than businesses, which are more focused on making money than national security.
For many companies, making stuff abroad is the only viable option, but they do need to continue functioning if something bad happens. That’s why Fisher thinks the question companies will be asking isn’t “is our supply chain too long?,” but rather “should we be investing in resilience of the [complex, international] supply chain?”
The ‘just-in-time’ model cracks
Companies don’t just buy stuff from far away, but they have been buying the least amount of stuff possible — running lean inventory and only buying when they need to.
That’s called the “just-in-time” inventory model, and like predicting months in advance when buying from afar, companies have gotten really good at creating models that allow them to run extremely efficiently. The downside of this model is it’s fragile: If something goes wrong, companies will be in a bind.
So, when the coronavirus hit, some companies and consumers experienced supply issues.
But what should a company do if they operate under this model?
“Largely speaking [just-in-time] isn’t going to be redesigned for a 100-year crisis,” said Siegel. “It’s almost impossible to plan for something that happens every 100 years.”
This may sound like a gamble, but for many companies, changing the entire model just doesn’t make sense. As Yossi Sheffi, director of the MIT Center for Transportation and Logistics, told Yahoo Finance, there are just too many advantages of “just-in-time” that go beyond cost. There’s more speed and agility, but also more quality.
When an auto production line experiences a problem with a part, for example, you have a pile of parts and swap a new one in. But with just-in-time, “you stop the line, find out what’s wrong, and fix it,” Sheffi said. “Low inventory helps people find out what’s wrong.”
For some stuff, however, we may see significant changes in inventory management. The pandemic has shown that the critical strategic reserves of products like ventilators and personal protective equipment are simply not adequate during a global emergency. The U.S., unable to import ventilators quickly due to other countries’ export laws, resorted to deputizing General Motors (GM) to make ventilators.
For many, that wasn’t quick enough, and shifting the permanent production domestically may not be feasible either in the future. But what might be more practical is planning for more inventory.
“If you have 100,000 ventilators that you could pull out at a moment’s notice, that’d be easier [than it would be] to nationalize GM via the Defense Protection Act,” said Siegel.
Going forward, the government may choose to mandate that certain companies run with more inventory for critical items like ventilators, just in case, and keep their own warehouses better stocked.
What will change: diversification
For the most part, however, just-in-time inventory is here to stay, and low-cost offshoring isn’t going anywhere. But what Yossi, Siegel, and Fisher agree will change is diversification.
“The first line of defense is to make your components in multiple places,” said Fisher. “The idea is at least two companies making it in two geographic locations.”
“I expect companies to have at least a secondary supplier,” said Sheffi. “Not 50%, maybe 20-30%.”
Rising wages in China have forced some companies to move their manufacturing away from the country, said Fisher, but many companies are still exposed.
Fisher noted that the 2011 Tsunami in Japan taught many companies, like Apple, the lesson to be more robust in the face of disruption, but that as the disaster faded into memory, so did the calls to diversify.
“Apple [has] foregone the few millions of costs to make the supply chain more robust and lost $100 billion in market cap,” he said. “The needle has tipped too much to efficiency from robustness.”
Since then, the volleys of tariffs and uncertainty during the trade war with China caused companies to realize that relying solely on that country for manufacturing exposed them to big risks. Many companies, including Apple (AAPL), decided it would be a good idea to get more baskets to put their eggs in. Inadvertently, the U.S.-China trade war prepared some companies for the coronavirus pandemic. But few had made any big moves by the time the coronavirus hit.
This, Fisher said, is a wakeup call.
“What companies will do is map their supply chain, look at everything that goes in,” said Fisher. “And those supply chains can be 10 layers deep. Foxconn gets things from other suppliers, which get them from another.”
What you get from this is a figure called “revenue at risk,” which helps underscore the amount of money that is at stake should one link break in the chain. By adding other suppliers, that number can be brought down, avoiding a catastrophic stoppage for a business.
But given that this is somewhat of a 100-year storm — literally, the last major pandemic was in 1918 — the question remains: how many companies will simply roll the dice instead?