Saturday, Apr 4, 2020
International Finance
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Epidemics in China: Reducing global supply chain risks

Epidemics in China - Corona Virus
How do you build resiliency into global electronics and hitech supply chains given China’s vulnerability to epidemics?

The global supply chains of hitech and electronics companies are under serious threat from the coronavirus epidemic in China. Closed ports and delayed shipments are forcing different players in the global value chain to reconsider their targets for the year. The impact of the outbreak, especially on the consumer electronic and telecom equipment supply chain could prove to be disruptive for the industry, however, it is too early to judge the full impact of the virus outbreak as of yet.

The coronavirus outbreak, which has been compared to the SARS outbreak in 2003, could have a far greater effect on the global economy compared to SARS 17 years ago. Over the years, China has developed itself as a global manufacturing hub, its supply chain connecting its market to markets in all corners of the world. The logistics network over the years have also become more sophisticated and nowadays, demands are met at a very fast pace. The epidemic could result in China facing challenges such as shortage of labour and materials, travel restrictions as well as logistical challenges. The inability to meet demand could result in billion dollar losses throughout the supply value chain.

Coronavirus disrupts global consumer electronics supply chain

The supply chain networks for consumer electronics manufacturers or technology companies are the ones heavily affected by the Covid-19 outbreak. A majority of the components used to produce consumer electronics are manufactured in China. Foxconn, the world’s largest contract manufacturer of electronics, currently operates 12 factories across China. The Taiwan-based electronics giant also has a production unit in Wuhan. Foxconn serves global companies such as Apple, Dell, Amazon, Cisco and Hewlett-Packard.

The outbreak has also forced Samsung to move the components for the latest galaxy phones from China to its manufacturing hub in Vietnam. Reportedly, Vietnam is also limiting the transport volume between the two countries. Vietnam too, has reported numerous cases of Covid-19 this year. South Korea-based LG Electronics, which produces a major chunk of its mid-range in Vietnam is also facing disruption in its supply chain.
Catalina Stefanescu-Cuntze, professor of management science at ESMT Berlin told International Finance that it is rather early to make a confident assessment of the extent of disruption, given that the virus is still spreading with new cases confirmed daily and with disruption still ongoing. She said, “But I think we can safely say that the impact of the coronavirus on supply chains will be larger than that due to the SARS outbreak in 2003. Since then, the Chinese economy has become much more deeply integrated into the global supply chains, and China overall accounts now for roughly one-sixth of global economic output. So the potential for disruption has also increased significantly.”

So far many suppliers in China have announced a delay of around two to three weeks. They have also issued a warning that the delay could be longer than predicted depending on conditions. Some of the manufacturers in China have also reported a shortage of labour. Apple has already revealed that it would miss its estimate for quarter-end revenue due to the epidemic in China. Gianfranco Lanci, COO at Lenevo – the largest PC maker by unit sales, revealed that the entire industry will not have enough supply. Daikin Industries, a Japanese multinational air conditioning manufacturing company, which has a production unit in Wuhan, is mulling moving the unit to a nearby Southeast Asian country, notably Malaysia.

However, the disruption caused will vary from companies and on how they operate. Some manufacturers may not have a plant in China, but it will depend on supply coming out of China in one way or another. Robert Boute, Professor of Operations Management at Vlerick Business School told International Finance, “The extent to which the coronavirus has disrupted supply chains really is dependent on how a company operates. Of course, companies who directly supply from China will be hugely affected by this, with a large amount of production coming to a halt in the country, which will directly affect the supply that these companies can obtain.”

But, a lack of supply from China is also likely to have a huge impact on companies who don’t directly purchase components from China. This is because, with many products have long lines of a supply chain, it is likely that at some point along this chain, there will be some interaction with Chinese companies. This is what we call ‘tier 2’ suppliers. There is a lot less transparency in this, and many companies may interact with Chinese companies through their supply chain without even realising – through this method a lot more companies will see disruption to their supply, and are likely to take longer to react to this also.

Coronavirus impact spreads to Southeast Asia and beyond

The impact of the Covid-19 epidemic is not only limited to China. Before the virus could be contained in its place of origin, it has spread to other Southeast Asian countries and now it has reached Europe and the Middle East. With these countries also having a role to play in the global supply chain network, disruption is certain. According to The American Chamber of Commerce in Singapore, 72 percent of global businesses operating in Singapore expect the Covid-19 to impact their revenue. A survey revealed that 43 percent of the logistics companies operating in APAC have been greatly affected by Covid-19. Around 37 percent of the manufacturing companies in the region have also been greatly affected by the epidemic. A majority of the respondents in the survey expect their revenue to drop in the margin of 1 percent to 10 percent.

Vietnam too is set to suffer billion-dollar losses and its GDP growth rate is expected to drop by one percent for the year. Due to border closure, export and import business has taken massive hits in the country. Consumer electronics and automobile manufacturers in Vietnam rely heavily on Chinese supplies. Many factories in the country have either temporarily shut down or reduced production because of the reduced materials coming from China.

Is Wilbur Ross’s wishful claim correct?
US Commerce Secretary Wilbur Ross recently claimed that the US will gain from the coronavirus outbreak in China. However, it may not be exactly true. Many US companies have production units in China or inversely rely on manufacturers in China. The Covid-19 outbreak will negatively affect companies in the US, according to Catalina Stefanescu-Cuntze. The impact of this will be more short-term than long-term, and it certainly isn’t as simple as Wilbur Ross states, added Robert Boute. It’s likely that some production, and therefore jobs, may return back to the US and the same for other countries, in the short-term to deal with a production crisis, however long-term, it is likely that once production levels pick up again in China and neighbouring countries that production will move back to these locations as they are a lot cheaper.

How do you hedge for China’s vulnerability to epidemics ?

Given China’s vulnerability to epidemics, how can companies prepare to better deal with a situation like this? When International Finance asked the question to Robert Boute, he said that there are two specific ways in which companies can prepare and limit the impact of epidemics such as the coronavirus on their supply chain – however, neither are the holy grail and completely effective.

He explained, “Firstly, one way is to implement a dual-sourcing method into the supply chain. This means that a company is not reliant on just one company or one location for its supply. This is likely to mitigate the risk of disruption in a supply chain, as if a company is unable, for some reason, to obtain components from one supply, then they are able to fall back onto the alternative supplier, to ensure they can continue to obtain their supply. However, there can be difficulties in this as the ‘tier 2’ supplier issues may come in to play again. Take the coronavirus as an example, companies could have somewhere in Europe as an alternative supplier, however, this company may also be reliant on a location or company affected by an epidemic at some point in their supply chain, meaning they may be halting or limiting production also.

Another way in which this impact could be combatted is through greater transparency in global supply chains. As previously mentioned, many companies are aware of where their immediate supplies come from, but not the supplies of their suppliers, and so on. There are a vast amount of players that come into one supply chain, and many are not completely aware of every company they interact with throughout a chain. Increasing the transparency of these supply chains will ensure companies are completely aware of every single company involved in their supply chain, and exactly where all components come from.”

This full transparency, of course, is very difficult to ensure. This can be increased however by companies collaborating together to improve the digitisation of their supply chains. In doing so, companies can track exactly how their supplies are arriving, therefore allowing companies to mitigating many risks on the way.”
Replying to the same question, Catalina Stefanescu-Cuntze told International Finance that if the epidemics-led disruption is relatively short-term, building additional inventories in the critical points of the supply chain can help weather the supply shock by ensuring that demand can still be met (at least to some extent) until production returns to normal, as it eventually will. For medium-term disruptions, likely the most effective strategy is to diversify away from the supply chain risk by redistributing parts of production to alternative geographic regions. Either of these strategies will entail additional costs.

Some manufacturers might try to mitigating the impact of the virus by moving production elsewhere in Asia. Robert Boute believes it could be an option, but of course, there many other countries, especially in Asia, that are also affected by the coronavirus, and are also halting production. Dual-sourcing production is the best way in which to counter act these breakouts, although as previously stated it is not a complete fix to the problem. Companies should look to have another source of production that is far away in location to their other source.

Contingency planning for virus outbreaks in China

Be it SARS in 2002 or Covid-19 in 2020, there are many lessons to be learnt by corporates that can help better prepare for such an unprecedented situation in the future. Some companies do have a continuity plan for scenarios such as earthquakes or floods. But currently, not many companies at all have continuity plans centered on epidemics such as the outbreak of a virus as they are of course nowhere near as common or easy to predict as a potential earthquake or flood. Robert Boute said that not many firms will look to build further continuity plans around viruses such as the coronavirus, as they are still incredibly rare.

He said, “What this has taught us however is just how vulnerable our supply chains really are in terms of unpredictable risks. It also shows us how vulnerable companies are when using single sourcing strategy, and illustrates the perils and knock-on effects of these supply chains on almost all companies.”

Another important lesson to learnt from this is that companies should be looking to improve the transparency of their supply chains, collaborating together to make each other away of exactly all the parties involved in making a certain product. By citing Boeing’s supply chain during the launch of its Dreamliner aircraft as an example, Robert stresses that not being transparent in the supply chain could lead to delay in supply as in the case of Boeing, where production was three years late due to incredible numbers of outsourcing, and not knowing the specific details of their supplier’s suppliers and so on down the chain.

Another important point to be noted is also supply chain’s reliance on China, or in fact, its reliance on a single market is bound to increase risk one way or the other. Many companies have already carried out feasibility studies last year to move their units out of China, in light of the US-China trade war. Also, factors such as rising labor costs, increasing competition and political instability in China have already added to the uncertainty. Catalina Stefanescu-Cuntze believes a re-balancing of the manufacturing base towards a broader range of economies can certainly help to hedge by diversifying the global supply chain risk. But there are also costs associated with this strategy – China has extensive transportation and logistics systems and a vast and skilled worker base, so re-distributing production away from China may entail higher costs or lower quality, at least in the short-run.

Building supply chains resiliency with China’s vulnerability in mind

Since an epidemic like the corona-virus is not a regular occurrence and hard to counter efficiently, it is also difficult for companies to come design a model to protect itself from such instances in the future. There are epidemiological models of infectious disease spread that can provide some guidance as to possible scenarios; computational disease modelling is well-established as a field. The challenge is, however, that the uncertainty related to these predictions is such that effective contingency planning is still difficult, in practice. For such models to be a success the availability and quality of this data, especially in the early stages of the outbreak are crucial. As international organisations and national health systems increase their coordination and information sharing in response to each outbreak, and as more data sources can be incorporated into the models, the increasing quality of the available data will hopefully also lead to more useful predictions for contingency planning.

Catalina Stefanescu-Cuntze said that the focus over the last couple of decades on lean manufacturing, offshoring, and supplier consolidation had the benefit of achieving substantial efficiency gains for global companies operating in very competitive markets. However, that same focus also had the effect of significantly increasing the overall global supply chain risk, by concentrating manufacturing facilities while also reducing inventory levels that limit the reactive capacity in case of a disruption. Supply chains have become more integrated, but at the same time less flexible. Ultimately, increasing supply chain resiliency depends on individual players’ decisions on the trade-off between managing risk and lowering costs.

Many companies prefer setting up production plants in China or other Asian countries due to its pricing factor. But since such countries are prone to epidemics, it is important for companies to look at production in a long-term model financially, and look to invest more in production to protect themselves from such risks, which will only be more costly in the long-term if they do occur. Robert Boute believes companies should not consider pricing as a major factor; instead, the focus should be continuous production.

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