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

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.

3. Decarbonization and Sustainability
Consumers, particularly those in European markets, are paying more attention to the carbon emissions associated with the transportation of their goods to market. Shippers, ocean carriers, and logistics service providers will face increased pressure to assess and manage their greenhouse gas emissions. Nearly two-thirds of corporate boards have now incorporated ESG goals into compensation plans, and the U.S. Securities and Exchange Commission is developing disclosure requirements. But disparate data collection methods and a lack of visibility into all the tiers of firms’ supply chains mean that most firms will struggle with reporting even when they are eager to be compliant.

Indirect costs, buried in higher logistics costs, are set to increase in 2023. The International Maritime Organization (IMO) agreed in June 2021 to a new set of guidelines to cut the carbon intensity of all ships engaged in international trade. Two new measures will come into force in 2023. Individual ships will be graded on an A-to-E scale, and those engaged in international trade will have to apply for an International Energy Efficiency Certificate at their first inspection after January 1, 2023. From then on, they will have to demonstrate annual improvement in their operational carbon intensity, an expensive challenge for older ships. That may involve costly retrofits, or some ships may choose to “slow steam” — sail at a lower speed — as a simple way to reduce carbon emissions. Coupled with container lines’ newfound capacity discipline, the era of cheap international container shipping may be over.

New environmental regulations are likely to become a more important factor in manufacturing location choices as well. The European Union’s proposed Carbon Border Adjustment Mechanism (CBAM), slated to become fully operational in 2026, will put a carbon tax on imports of selected products so that ambitious climate action in Europe does not lead to “carbon leakage.” While the first phase covers carbon-intensive sectors such as cement, iron and steel, aluminum, fertilizer, and electricity, this could have a significant impact on sectors such as industrial equipment where a significant proportion of the product cost is steel, castings, and forgings. It could apply to a broad range of imports over time.

Source: Harvard Business Review

4. Suppliers’ Health
The fourth area is one that has received little attention during the pandemic: the health of suppliers, particularly in more distant tiers of a supply chain. For example, while U.S. automakers have announced surprisingly strong earnings thanks to a shift to more profitable vehicles in the face of constrained component supplies, many smaller suppliers have struggled with surging raw material costs that they have been unable to pass along. Some report that U.S. automakers refuse to even discuss material cost increases. On top of the cost increases, firms described to me how large customers are dragging out the payment of their receivables, putting small companies under intense cash pressure. “You’re so far underwater, you have no chance,” a manager at one supplier told me. “When we go in to talk to them about it, they shut the discussion down.” A manager at a another supplier said, “They refuse to even meet with us and just say they have a fixed price contract.”

The problem is that many original equipment manufacturers (OEMs) have approached their suppliers transactionally, focusing mainly on price. If managers want flexibility and resilience, this dictates a more strategic approach, recognizing the costs to suppliers of maintaining surge capacity, and doing a better job of shared demand planning. Firms should also reexamine some of the ways they incentivize their procurement organizations. After all, suppliers who can’t stay in business hardly make for a resilient supply chain.

Supply-chain management is entering a new era. The relatively benign environment of the last three decades, during which we saw tremendous growth of the tradable sector and the expansion of far-flung global supply chains, is probably over. We will still see trade growth, as it is difficult for any country or region to be self-sufficient in all the goods and materials consumed by modern economies. But the new focus on resilience and sustainability is going to present managers with fresh choices and challenges as they reorient their production footprints to ones that will be more flexible and more regional.

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