Are the Risks of Global Supply Chains Starting to Outweigh the Rewards? – Part One

The conflict in Ukraine is only the latest jolt to global supply chains. Disruptions caused by the Covid-19 pandemic, climate-related events, and geopolitical tensions were already undermining their rationale. As companies rethink sourcing, they will have to consider new factors concerning geography and geopolitics, logistics, decarbonization and sustainability, and suppliers’ health.

Historically the focus of supply-chain managers has been sourcing: managing the flow of materials and resources as they move through value-adding stages until they become finished products and services all the way to the point of delivery to customers.

But the multitude of shocks caused by the Covid-19 pandemic, a new urgency in reducing greenhouse gases, and geopolitics, plus the war in the Ukraine, have put the fragility of global supply chains top of mind. As managers navigate this dynamic, they need to think beyond product costs and supplier choices. Here are four dimensions that they should consider.

1. Geography and Geopolitics
Over the last three decades, firms have taken advantage of reliable, low-cost transportation and a benign trading environment to leverage low-cost labor in Asia to deliver a plethora of products to distant markets. But now supply-chain “resilience” is getting tangled with economic and technological “sovereignty,” a euphemism for more localized production.

The continuing U.S.–China trade war got the debate ongoing, but the pandemic accelerated it by exposing the depth of cross-border dependencies. Restrictions on the export of essential medical goods and vaccines early in the pandemic sent a strong message to governments who were caught short. Officials of one small country shared that it had a neighbor restrict its supply of fresh produce, causing it to question its supply security for just about everything.

Trade restrictions, even if they are temporary, weaken trust and give countries the excuse to implement industrial policies in the name of resilience and self-sufficiency. Most recently, the war in Ukraine has renewed attention to the supply of raw materials such as metals, noble gases, and agricultural commodities.

The broad impact of the semiconductor chip shortage during the pandemic exemplifies the pressure to shift supply chains. In the United States, this issue has become conflated with the loss of American leadership in advanced semiconductors and has led to major legislation to promote domestic investment. But the United States is not alone: The European Union and Japan have also jumped in with efforts to rebuild their shares of global chip production, and China’s “dual circulation” policy, launched in 2020, is aimed at lessening its dependency on imported strategic materials, including computer chips. Under the banner of “resilience,” we are seeing the rapid growth of industrial policy initiatives.

Managers who have relied on labor arbitrage or distant global sourcing strategies increasingly will have to develop regional alternatives. This likely will mean more balancing of production capacity and consumption within geographic trade blocs. Such blocs can largely be drawn to encompass a breadth of capabilities and resources — for example, a North American bloc that includes the U.S., Canada, Mexico, and parts of Central America that can together offer large markets, skilled as well as low-cost labor, and relatively lower transport distances and costs. Similarly, one can envision a European bloc that draws on Eastern Europe and North Africa for low-cost labor.

That’s not to say that all production will necessarily be localized. Large parts of the auto industry have generally focused on producing narrow ranges of models at individual sites and then exporting some proportion of their output to other markets so that they can offer a full range of products everywhere. One can imagine regions that manage to stay politically nonaligned, such as Southeast Asia, serving as a production base for multiple blocs.

I also envision a scenario where a firm concentrates major parts of production in two or perhaps three sites centered within major trade blocs and then exports some intermediate materials and finished goods to markets in other blocs. But in order to promote flexibility, this will necessitate the development of both production capacity and strategic capabilities in those diverse locations.

Such a strategy would enable pivots as circumstances change; the need for such flexibility has been demonstrated repeatedly over the last two years. But for capital-intensive sectors that rely on in-the-ground fixed assets and balanced utilization, that will mean distributing capabilities and not necessarily concentrating them in one region. This is starting to play out in semiconductors as Asian leaders such as Taiwan Semiconductor Manufacturing Company (Taiwan Semiconductor Manufacturing Company (TSMC)) and Samsung increase the geographic diversity of their footprints. Transitioning to this will be a long and expensive process, so the movement that has begun reflects a changed long-term view of the world.

Source: Harvard Business Review

2. Logistics
That brings us to the next dimension: logistics. Historically the logistics links that connect different parts of global supply chains have been taken for granted — or at least have not received the attention that they probably deserved. Predictable costs and performance for ocean and air cargo meant firms confidently built geographically distributed supply chains leveraging cost or scale advantages of Asian factories. Managers didn’t give that much weight to distance and shipping when planning product sourcing strategies; they just assumed that it would get done. Those days are past.

The breakdowns over the last two years due to pandemic-related disruptions, climate-related events, and accidents such as the blockage of the Suez Canal have exposed a dichotomy. While almost all firms experienced higher costs and suffered from bottlenecks and congestion, some fared much better than others. Those that could spot logistical problems relatively quickly, most often because of their scale and direct involvement in logistics operations, were able to respond much earlier during the pandemic. Firms that had people on the ground in China had a much earlier view of the initial factory shutdowns in early 2020 and could see the congestion building on the major trade lanes by the second half of 2020. Companies (mainly smaller firms) that were insulated by third-party logistics providers or freight forwarders were slower to see the wave of problems coming and suffered disproportionately.

Yet critical information is readily available for firms that know what to look for. The dramatic increases in air cargo and spot market ocean container rates were predictable because of congestion and the contraction in capacity caused by delays, but managers need to be attuned to watch for these signals. Identifying patterns at the beginning of an ocean-shipping-transit cycle rather than at the end can give managers as much as a 30-day head start on problems on the receiving end, yet many fail to take advantage of this.

More broadly, increased logistics costs call into question the practice of moving relatively bulky and lower-value (per unit volume) goods over long distances for processing, whether it is sending metals ore or rare earth minerals to China for processing before an onward journey to markets where they are consumed or Alaska-caught fish to China for processing and freezing before re-export to the United States. Historically this has been driven by labor arbitrage or environmental issues associated with processing, but those practices make less sense as transport costs stay at elevated levels or when supply security is critical. It will take time to establish many processing capabilities within market blocs, but the rationale for doing so is now as strong as it has been in decades.

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