The supply chain crisis has impacted my company: what is my next step?

If you are a retailer, or a business rescue practitioner/turnaround professional trying to help your clients address their financial distress, you are probably sick and tired of hearing about the global supply chain crisis and the impact that it is having on your clients.

I come with some bad news; if you thought that your clients hit rock bottom, there is still a fair amount of distress to be found as the crisis is showing no signs of abating. Shipping accounts for the movement of at least 90% of goods around the world and the cost of transporting things by sea has rocketed in the past year. For example, the Drewry world container index, measuring the cost of moving a 40ft container, is 170% higher than it was a year ago. The price on some particularly in-demand routes such as Shanghai to Rotterdam has increased by almost 200%. In the case of the Rotterdam to New York, the cost has risen by 212%. This means that your clients will have to fork out a lot more for the products that they sell.

I also come with good news. For those of you who are keeping a close eye on this chess board and considering your next more, there are strategies that you can use to help your clients address these challenges.

Uncover and address hidden risks
I recently came across an interesting article on the Harvard Business Review (HBR) website. The article points out that modern products often incorporate critical components or sophisticated materials that require specialized technological skills to make. It is very difficult for a single firm to possess the breadth of capabilities necessary to produce everything by itself. Consider the growing electronics content in modern vehicles. Automakers aren’t equipped to create the touchscreen displays in the entertainment and navigation systems or the countless microprocessors that control the engine, steering, and functions such as power windows and lighting. Another more arcane example is a group of chemicals known as nucleoside phosphoramidites and the associated reagents that are used for creating DNA and RNA sequences. These are essential for all companies developing DNA- or mRNA-based Covid-19 vaccines and DNA-based drug therapies, but many of the key precursor materials come from South Korea and China.

The article adds that manufacturers in most industries have turned to suppliers and subcontractors who narrowly focus on just one area, and those specialists, in turn, usually have to rely on many others. Such an arrangement offers benefits; you have a lot of flexibility in what goes into your product, and you’re able to incorporate the latest technology. But you are left vulnerable when you depend on a single supplier somewhere deep in your network for a crucial component or material. If that supplier produces the item in only one plant or one country, your disruption risks are even higher.

Identify vulnerabilities
The article points out that understanding where the risks lie so that your company can protect itself may require a lot of digging. It entails going far beyond the first and second tiers and mapping your full supply chain, including distribution facilities and transportation hubs. This is time-consuming and expensive, which explains why most major firms have focused their attention only on strategic direct suppliers that account for large amounts of their expenditures. But a surprise disruption that brings your business to a halt can be much more costly than a deep look into your supply chain is.

The goal of the mapping process should be to categorize suppliers as low-, medium-, or high-risk. To do that, Tom Linton, who served as a supply chain executive at several major companies, and MIT’s David Simchi-Levi suggest applying metrics such as the impact on revenues if a certain source is lost, the time it would take a particular supplier’s factory to recover from a disruption, and the availability of alternate sources. (Disclosure: I am on the boards of directors of Flex, a large manufacturing and supply-chain services provider where Linton is a senior adviser, and Veo Robotics, a company that has developed an advanced vision and 3D sensing system for industrial robots.) It’s vital to ascertain how long your company could ride out a supply shock without shutting down, and how quickly an incapacitated node could recover or be replaced by alternate sites when an entire industry faces a disruption-related shortage.

The article adds that the answers to those questions depend, in part, on whether your manufacturing capacity is flexible and can be reconfigured and redeployed as needs evolve (as is the case for many manual or semiautomated assembly operations) or whether it consists of highly specialized and difficult-to-replicate operations. Examples of the latter include production of the most advanced smartphone chips, which is concentrated in three facilities in Taiwan owned by the Taiwan Semiconductor Manufacturing Company; fabrication of exotic sensors and components, which happens largely in highly specialized facilities in a handful of countries, including Japan, Germany, and the United States; and refining of neodymium for the magnets in AirPods and electric-vehicle motors, almost all of which is done in China.

Once you’ve identified the risks in your supply chain, you can use that information to address them by either diversifying your sources or stockpiling key materials or items.

Diversify your supply base
The HBR article points out that the obvious way to address heavy dependence on one medium- or high-risk source (a single factory, supplier, or region) is to add more sources in locations not vulnerable to the same risks. The U.S.-China trade war has motivated some firms to shift to a “China plus one” strategy of spreading production between China and a Southeast Asian country such as Vietnam, Indonesia, or Thailand. But regionwide problems like the 1997 Asian financial crisis or the 2004 tsunami argue for broader geographic diversification.

Managers should consider a regional strategy of producing a substantial proportion of key goods within the region where they are consumed. North America might be served by shifting labor-intensive work from China to Mexico and Central America. To supply Western Europe with items used there, companies could increase their reliance on eastern EU countries, Turkey, and Ukraine. Chinese firms that want to protect their global market share are already looking to Egypt, Ethiopia, Kenya, Myanmar, and Sri Lanka for low-tech, labor-intensive production.

The HBR article points out that reducing dependency on China will be easier for some products than others. Things like furniture, clothing, and household goods will be relatively easy to obtain elsewhere because the inputs—lumber, fabrics, plastics, and so forth—are basic materials. It will be harder to find alternative sources for sophisticated machinery, electronics, and other goods that incorporate components such as high-density interconnect circuit boards, electronic displays, and precision castings.

Building a new supplier infrastructure in a different country or region will take considerable time and money, as China’s experience illustrates. When China first opened its special economic zones in the 1980s, it had almost no indigenous suppliers and had to rely on far-flung global supply chains and on logistics specialists who procured materials from around the world and kitted them for assembly in Chinese factories. Even with the support of government incentives, it took 20 years for the country to build a local base capable of supplying the vast majority of electronic components, auto parts, chemicals, and drug ingredients needed for domestic manufacturing.

The HBR article points out that shifting production from China to Southeast Asian countries will necessitate different logistics strategies as well. Unlike China, those locations often do not have the efficient, high-capacity ports that can handle the largest container ships or the direct marine liner services to major markets. That will mean more trans-shipment through Singapore, Hong Kong, or other hubs and longer transit times to reach markets.

In the long run, though, it would be a mistake to cut China completely out of your supply picture. The country’s deep supplier networks, its flexible and able workforce, and its large and efficient ports and transportation infrastructure mean that it will remain a highly competitive source for years to come. And because China has the second-largest economy in the world, it is important that firms maintain a presence to sell in its markets and obtain competitive intelligence.

Hold intermediate inventory or safety stock
The article adds that if alternate suppliers are not immediately available, a company should determine how much extra stock to hold in the interim, in what form, and where along the value chain. Of course, safety stock, like any inventory, carries with it the risk of obsolescence and also ties up cash. It runs counter to the popular practice of just-in-time replenishment and lean inventories.

However, the savings from those practices have to be weighed against all the costs of a disruption, including lost revenues, the higher prices that would have to be paid for materials that are suddenly in short supply, and the time and effort that would be required to secure them.

Robin Nicholson is a Director at Corporate-911 and is a Senior Business Rescue Practitioner