“As scientists race to develop a cure for the coronavirus, businesses are trying to assess the impact of the outbreak on their own enterprises,” wrote MIT professor Yossi Sheffi in a February 18 article in the Wall Street Journal. “Just as scientists are confronting an unknown enemy, corporate executives are largely working blind because the coronavirus could cause supply-chain disruptions that are unlike anything we have seen in the past 70 years.”
Sheffi is Director of the MIT Center for Transportation and Logistics. He’s written extensively on the critical need for resilience in global enterprises and their supply chains, - including The Power of Resilience and The Resilient Enterprise, - so they can better react to major unexpected events. Covid-19 is the kind of massively disruptive event he had in mind when he wrote those books.
While learning from historical precedents is always a good idea, recent supply chain disruptions - the 2003 outbreak of SARS in Asia, the 2011 Fukushima nuclear disaster, or the 2011 Thailand floods, - were very different from our current pandemic. Those events were much more localized, lasted a relatively short time, and they mostly impacted supply, not demand. The impact of Covid-19 is much bigger, affecting consumer demand as well as supply chains all over the world, and likely to last quite a bit longer. “Today’s supply chains are global and more complex than they were in 2003,” with factories all over the world affected by lockdowns and quarantines. Apple, for example, works with suppliers in 43 countries.
In a more recent article on how to manage what he called a Whack-a-Mole Recovery, Sheffi wrote that “Pressure to reopen the world’s economies is intensifying. However, hasty reopenings will likely spur waves of resurging infections in location after location, followed by more closures and quarantines. Global economic recovery after the pandemic-imposed shutdown, therefore, is not likely to be V-shaped, U-shaped, L-shaped, or W-shaped.”
“Instead, as the number of infections, hospital admissions, and deaths cycles up and down, chaotic cycles of economic rebirth and relapse will plague businesses and their supply chains. Businesses face a game of global whack-a-mole, as the COVID-19 virus rears its head or subsides in the cities, states, and countries that host the far-flung supply chains on which companies rely.”
How should companies manage their supply chains in such an uncertain, whack-a-mole environment? Conventional approaches - e.g., demand forecasting, production planning, - rely on historical data, and there’s no such data on this once-in-a-lifetime massive event. “Given this constraints,” says Sheffi, “the words of General Dwight Eisenhower ring true: Plans are useless, but planning is indispensable.”
Planning in such highly uncertain times must focus on the ability to quickly and flexibly react to fast changing circumstances. Doing so effectively, requires that the company has thoroughly mapped its supply chain, including the physical locations of its suppliers’ plants and warehouses, so it can quickly identify which of its products might be affected by a shutdown at any of the suppliers’ locations. Such a mapping cannot be done on-the-fly. Instead, it should have been done as part of the company’s resilience planning, - especially for large, complex enterprises that typically have thousands of suppliers all around the world.
In his WSJ article, Sheffi recommends that given the many unknowns accompanying major supply chain disruptions, companies should adopt several sensible just-in-case steps, including:
- Set up a central emergency management center with clear decision-making rules;
- Establish key priorities for which products should be built and which customers should be supplied first if capacity is significantly reduced;
- Determine which of the company’s suppliers make critical parts, track their inventories, and establish potential alternate sources;
- In the near term, plan operations that will maximize cash flow rather than profits;
- Maintain close communications with national and local authorities as well as with colleagues and partners on the ground.
“Hoping for the best while preparing for the worst may not seem like a rigorous business approach to the crisis. But given our lack of knowledge, it is the most prudent strategy for managing risk.”
Let me now turn to the long term impact of the pandemic on supply chains. In the longer term, the pandemic will generally accelerate existing trends, - e.g., the rate and pace of digitization, AI adoption, robotics and automation. As a recent article in The Economist pointed out, the transformation of global supply chains is another major trend that will be accelerated by Covid-19.
“That companies have been aflurry over their supply chains is not in doubt,” said The Economist. “From January to May supply-chain disruption was mentioned nearly 30,000 times in the earnings calls of the world’s 2,000 biggest listed firms, up from 23,000 in the same period last year. Mentions of efficiency declined from 8,100 to 6,700. Managers know that supply chains are good conduits of economic pain.”
However, the article added, global firms are proving quite resilient to the pandemic. Despite the impact of the virus on their production facilities, “the sinews of business have, for the most part, held up remarkably well… This is not to say that business is booming. But it is demand, not supply, that is lacking. To the extent that the sinew is not working it is for want of a task, not for want of strength.”
The pandemic will likely accelerate a number of ongoing supply chain efforts. These include bringing production closer to home, a diverse supplier base, and spare manufacturing capacity and inventories. Let me briefly discuss.
A number of far-flung supply chains will be replaced by national and regional ones, especially for critical supplies like those in the medical and pharmaceutical sectors, and for complex production where assemblies have to cross borders repeatedly. The Economist cites the example of automotive supply chains, 59% of which are already intraregional. Over the past three years, China’s share of car parts imported by the US fell by 2.2%, while the share coming from elsewhere in North America increased by 2.8%.
Over time, it’s quite possible that companies in developed economies will attempt to set up new clusters of national and regional production, relying on technology and automation instead of labor cost arbitrage. Zara, the Spanish apparel retailer, is an example of a company that has set up a diverse regional supplier base, not only to help avoid the pain of disruptions but to also help them react faster to changing tastes in fashion. Zara’s different apparel lines reach their shops independently, rather than being part of a highly integrated supply chain.
Another way to reduce the pain of disruptions is by maintaining spare manufacturing. “Though companies may pride themselves on their lean manufacturing, the world’s factories do not typically run at full tilt: across the world the proportion of their potential capacity which industrial firms actually use has been flat or falling over the past two decades.”
Finally, there’s inventory on hand. “It is widely assumed that modern supply chains relentlessly eat away at this source of resilience, but that is not entirely true. Investors can punish firms if they start piling up stock, especially if there are other signs of trouble. But they also look askance at firms that cut too close to the bone.”
It’s hard to predict the long term impact of the pandemic on efficiency-resilience trade-offs while still in the middle of the storm. Will there be a significant shift in the balance toward resilience? Or, will a company which invests on resilience end up at a competitive disadvantage if others in their industry survive without making such provisions? Time will tell.
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